A less common example of a contra asset account is Discount on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable. By reading these financial statements, an individual will see the full financial picture of the company in question.
- The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels.
- To oppose the revenue made by a company, contra revenue accounts must have a debit balance.
- In bookkeeping terms, a contra asset account refers to an account which is offset against an asset account.
- Contra liability accounts are mainly used by corporations that issue bonds frequently.
- A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification.
The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable. The net of these two figures is typically reported on a third line.
Cash Flow Statement
This is an owner’s equity account and as such you would expect a credit balance. Other examples include (1) the allowance for doubtful accounts, (2) discount on bonds payable, (3) sales returns and allowances, and (4) sales discounts. For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts. The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances. A separate account used in such a situation is sometimes called a adjunct account. In an accounting system, ledger accounts are designed to contain only similar transactions and/or balances. A separate account is needed whenever the nature of transactions changes. It is because clubbing together dissimilar transactions impedes any analysis. For example, we need separate accounts to hold the actual cost of property, plant and equipment (PPE) and related accumulated depreciation.
- There can be hidden value in stocks that have a lot of fully depreciated buildings.
- Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value.
- For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account.
- For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances.
The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Therefore, a contra asset can be regarded as a negative asset account.
Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. The cost variances in accounting, 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. Sometimes, we have an ancillary balance whose normal balance is the same as that of the parent account.
Trial Balance
That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. 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. Contra liability, equity, and revenue accounts have natural debit balances.
The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. A contra account is a negative account that is netted from the balance of another account on the balance sheet. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
Example of a contra account
By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. 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. 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. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability.
A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. However, some asset accounts need a negative counterpart to reduce the balance of that account.
How to Use Contra Asset Accounts
Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period. The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company’s auditors. The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level.
Contra asset accounts
Offsetting the asset account with its respective contra asset account shows the net balance of that asset. In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account. In other words, the contra liability account is used to adjust the book value of an asset or liability.
What is Contra Account?
Contra asset accounts are reported with the related account on the same financial statement. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time.
While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger. 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. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.