Contra accounts definition

It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables.

Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts.
The main advantage of using a contra asset account is to separate this reduction from the asset account with which it is paired.
The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable.

Accounts use this method of estimating the allowance to adhere to the matching principle. The matching principle states that revenue and expenses must be recorded in the same period in which they occur. Therefore, the allowance is created mainly so the expense can be recorded in the same period revenue is earned.

Historical Percentage Method

Note that if a company believes it may recover a portion of a balance, it can write off a portion of the account. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.

For example, say the company now thinks that a total of $600,000 of receivables will be lost.
Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.
In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount.
Rather, it is an adjunct account or a valuation account that is added to the face value of the bonds to arrive at the carrying value (or book value) of the bonds on the balance sheet.

Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. A contra asset is paired with an asset account to reduce the value of the account without changing the historical value of the asset. Examples of contra assets include Accumulated Depreciation and Allowance for Doubtful Accounts. Unlike an asset which has a normal debit balance, a contra asset has a normal credit balance because it works opposite of the main account.

The Advantage of Using a Contra Asset Account

Contra asset accounts represent a realistic picture of your business’s financial health and ensure adherence to accounting standards. If you find managing contra asset accounts to be a daunting task, there lies a solution in outsourcing. Partnering with an outsourced accounting firm such as NOW CFO provides the specialized expertise necessary to manage these accounts effectively, allowing you to make informed decisions with confidence. Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance.

If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate. The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s balance sheet.

Contra Asset Journal Entry Accounting

Contra accounts play an important role in accounting by helping businesses track certain aspects of their finances more accurately. For example, contra revenue accounts can be used to track the full cost of sales less any discounts or returns. It can help businesses see the complete picture of their income and expenses. An example of contra equity with buying back shares or stock would be a company that has issued shares to the public. The contra equity account would be used to offset the equity account on the balance sheet. The company estimates that it will not be able to collect 1,000 from its customers.

Contra Account

The need for a contra asset account depends on the nature of the business and the types of transactions it engages in. Not all businesses will have fixed assets or accounts receivable that require the use of contra asset accounts. However, for those that do, contra asset accounts are an indispensable how to report farm rents on a schedule e tool. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation.

Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. Accruing tax liabilities in accounting involves recognizing and recording taxes that a company owes but has not yet paid. This is important for accurate financial reporting and compliance with… The Allowance for Doubtful Accounts is used to track the estimated bad debts a company my incur without impacting the balance in its related account, Accounts Receivable. An estimate of bad debts is made to ensure the balance in the Accounts Receivable account represents the real value of the account.

This would allow the company to track the amount of money that has been borrowed. The contra liability account would be used to offset the liability account on the balance sheet. An allowance for doubtful accounts is a contra asset account that is used to offset Accounts Receivable on the balance sheet.

Both of these accounts offset each other to represent a net balance on a company’s balance sheet. However, the details for contra accounts usually exist on the notes to the financial statements. However, these can cause a reduction in other balances on the statement. The contra asset account, accumulated depreciation, is always a credit balance. This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance.

Bookkeepers use the contra asset account to track reductions to an asset separately from the asset itself. The use of a contra asset account when recording transactions allows a company to report the original amount and also report a reduction so that the net amount will also be reported. This way, the relationship between certain debits and credits can also be easily tracked. A contra asset account is added right after the asset account it is used to reduce, but before net assets on the Balance sheet. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline.

The Contra Liability Account

In the realm of accounting, various techniques are used to ensure financial statements provide an accurate and comprehensive view of a company’s financial health. One such method is the use of contra accounts, a type of account that directly correlates and offsets a related account. Therefore, contra-asset accounts differ from other accounts that have a credit balance. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts. In response, the firm should decrease its accounts receivable and revenue balances.