Contra Account: A Complete Guide + Examples

Usually, companies add to the accumulated depreciation account after every accounting period. An asset account which is expected to have a credit balance (which is contrary to the normal debit balance of an asset account). For example, the contra asset account Allowance for Doubtful Accounts is related to Accounts Receivable. The contra asset account Accumulated Depreciation is related to a constructed asset(s), and the contra asset account Accumulated Depletion is related to natural resources. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset.

However, they will still appear on the notes to the financial statements with necessary disclosures. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. Instead, the existence of contra-asset accounts for companies will differ based on a company’s requirements. A contra-asset account is an account that opposes the balances of other asset accounts.

What Is a Contra Account?

By the end of 2nd-year, the machinery balance will still be $100,000, and accumulated depreciation will show $40,000. The netbook value of the machinery by the end of the first year will be $80,000 ($100,000-$20,000) and $60,000 ($100,000-$40,000) by the end of the second year. This method helps a third person identify what the book value was at the time of purchase and the remaining value of an asset. If we show $60,000 as an asset in the third year, it will be challenging to understand whether $60,000 is all new purchases or the remaining value of an asset. This account helps all the stakeholders understand the financial numbers accurately.

All accounts also can be debited or credited depending on what transaction has taken place. For example, when a vehicle is purchased using cash, the asset account “Vehicles” is debited and simultaneously the asset account “Bank or Cash” is credited due to the payment for the vehicle using cash. A contra asset account is an account that is used to offset another fixed asset account on the balance sheet. Contra asset accounts are typically used for accumulated depreciation, amortisation, and other accounting adjustments. For example, a company might have a contra asset account for depreciation expense and a separate asset account for equipment cost.

• Nor would it count as a liability as it does not reflect a future obligation.
• An asset that is recorded as a credit balance is used to decrease the balance of an asset.
• The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.
• Contra asset account is an important element of the balance sheet or the books of accounts.
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• The client’s payment history and status of communication should also be taken into consideration.

It also helps create reserves, and later any change in the expected number can be adjusted through allowances and reserves. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. It is necessary to distinguish between CapEx and current expenditures that are used for restocking or other regularly occurring needs. For example, payments of salaries to permanent employees or purchases …. This means that this person is not capable of paying the borrowed 1,000.

#2 – Contra Liability

Contra revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances. A liability recorded as a debit balance is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation.

CMS A content management system software allows you to publish content, create a user-friendly web experience, and manage your audience lifecycle. Construction Management This guide will help you find some of the best construction software platforms out there, and provide everything you need to know about which solutions are best suited for your business. This transaction records when a customer returns the paid goods, and a refund needs to be given. Trade accounts receivable refer to an amount that a company bills to its clients when delivering goods or services. These billings may usually be documented on invoices, which are then summarized in an aging report for all the business’s accounts receivable. Bad debt is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible.

• Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete.
• It is used to track and report adjustments, reversals, or reductions in the value of assets or liabilities.
• This account helps to give a more accurate picture of the company’s financial position.
• This method helps a third person identify what the book value was at the time of purchase and the remaining value of an asset.
• They are crucial for compliance with generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS).

Allowance for Doubtful Accounts

Accounting Accounting software helps manage payable and receivable accounts, general ledgers, payroll and other accounting activities. Sales allowance is the reduction in the selling price when a customer agrees to accept a defective unit instead of returning it to the seller. This would allow the company to track the amount of money that has been borrowed.

Example #1: Revenue Contra Account

To simplify bookkeeping, she created lots of easy-to-use Excel bookkeeping templates. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees.

Rather than pay this cost up-front and tie up a significant chunk of capital, Show-Fleur makes this purchase on credit with a 90-day due date after invoicing. Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings. Wanting to spruce up its aging inventory, Show-Fleur purchased new, climate controlled-seats for its fleet, delivering increased comfort for passengers and a cleaner, more modern look for vehicle interiors. The initial cost of this upgrade was $8 thousand per limo or $600,000 in total. Provision for a discount from creditors and discount on bills receivable are other widely used examples. It is only prudent to show the reduction or reserve in a separate account, and at any point, it gives us the netbook value explaining what the actual cost was and how much of that has been depreciated.

What Is A Contra Asset Account? Definition, Types, Example, And More

All in all, contra accounts are an important tool for businesses to use to understand their financial standing better. In this example, the accounts receivable is 10,000, and the allowance for doubtful debt contra account is 1,000, leaving a balance of 9,000. The allowance for doubtful accounts is used to reduce the net income by the estimated amount of uncollected receivables. This account helps to give a more accurate picture of the company’s financial position.

Contra asset accounts have a balance that is opposite from the regular asset accounts. In other words, a contra asset account maintains a credit balance instead of a debit balance. Contra Liability Account – A contra liability account is a liability that contra asset definition carries a debit balance and decreases other liabilities on the balance sheet. Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance. It ensures that financial statements accurately reflect a company’s financial position.

To compensate for those potential deadbeat customers, you can use a Bad Debts account to serve as a contra for your A/R. Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing. If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $10 thousand in discounts during that same timeframe. In reality, the actual number of company discounts came closer to $5 thousand. It can help companies see the complete picture of their income and expenses and their equity or net worth.

Just remember that they carry an opposite balance than the other accounts in their account type. Similarly, it allows companies to retrieve original account balances without complicated calculations. For stakeholders, looking at both accounts is also crucial in their decision-making process. The points below explain the importance of passing a contra account entry. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. If you occasionally sell some of your property, plant, and equipment (e.g. some machine or a car) it would not belong to inventories.

Contra equity accounts are typically used for a company to buy back its stock or shares. Below is the asset account debit balance and accumulated depreciation account credit balance on the balance sheet. Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired. Instead of increasing assets or decreasing liabilities (as would be typical when spending cash), buying treasury stock reduces shareholders’ equity.