What is a Contra Asset Account? Definition, Types, Example, and More

Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible. The balance sheet shows the amount in the asset section underneath the accounts receivable. The net value of both these figures is usually reported on a third line.

When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. Contra accounts are shown in the financial statements below the paired accounts, although sometimes the balances of the two accounts are merged to a net amount for presentation purposes. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account. In this way, an accumulated amortisation account offsets a related asset account (which is recorded as a debit). For example, Sales returns and allowances is a contra-revenue account, in which sales returns and allowances are separately accounted for in order to have a separate data for such items.

An example of recording a contra asset

A contra asset account is an account that opposes the balances of other asset accounts. As mentioned, a company will usually have debit balances in its asset accounts. Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Contra revenue accounts show the reduced gross income because certain asset expenses give a business a net revenue outlook.

A contra asset account is an account that is paired with and offsets the balance of a related asset account. It carries a credit balance, which is the opposite of the normal debit balance of asset accounts. The purpose of a contra asset account is to track and report reductions in the value of the related asset. Examples of contra accounts include Allowance for Doubtful Accounts, Accumulated Depreciation, and Return on Sales. The Johnson family’s purchase of furniture illustrated the effect on the financial statements for two kinds of contra accounts, revenue, and asset. Contra accounts are also used in other areas of the financial statements, such as an estimate on an uncontrollable percentage of credit sales in which the amounts listed must be estimable and probable.

Which is considered a contra account?

An organization would rather record $100,000 as an asset and would amortize $10,000 depreciation each year for the next 10 years. Depreciation is not directly reduced from the asset so that the historic value/fair value of the
asset could be presented in a balance sheet. This results in compliance with the accrual concept while reflecting on an accurate accounts receivable balance. Companies that hold inventories for a long time may face accumulating obsolete inventory.

• A contra account is where we record events that are contrary to a general ledger parent account, also called a relating account.
• At the same time, depreciation for the van at the end of the year ended up at $500.
• This type is paired with the asset account, which allows a business to record the original price or value of the asset at time of purchase.
• In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance.
• Similarly, it allows companies to retrieve original account balances without complicated calculations.

However, they will still appear on the notes to the financial statements with necessary disclosures. A company’s financial accounts will usually have three types of items. Assets are debit balances that include resources with expected positive future economic benefits. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. Note that in accounting, the term “book value” is also used interchangeably with net value.

Depreciation Expense Account Vs. Allowance for a Depreciation Account

A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance. Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. Whenever the balance of a CA account increases (credit to the CA account), the increased amount is written off as an expense and is reported in the company’s income statement. 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.

In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet. More specifically, record the contra asset as a credit that is supposed to balance out a correlating plant asset. The situations that contra asset accounts appear are the ones dealing with Depreciation, which will be explored below.

What is a Contra Asset?

A contra account is used in order to better portray the relationship between certain debits and credits within the overall financial structure of an entity. A contra account can be used to remedy an error, to track depreciation contra asset account of an asset, or to register payments that are not collectible. The aim of contra account is to reduce balance of the main account and provide a separate and clear data in the accounting on the substance of such decrease.

They want to take advantage of the interest free year of credit, so on December 5th they open a store account for the entire balance of $7,500 and make arrangements for delivery of the queen size bedroom set. However, if the billing office stopped there, you would overstate your assets and net income. You must also report the amount that you can reasonably expect will not be paid, if it is estimable and probable. You could simply adjust the parent account…but then you are missing an essential part of the story — how many patients were actually treated today for a sprain. To report the real value of the financial statement, you will need to record the amount you can reasonably estimate that will probably effect the financial statement classification. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.

The difference between an asset’s account balance and the contra account balance is known as the book value. In a balance sheet, accumulated depreciation would be reflected as a reduction from the asset’s account so that the net balance is evident. Allowance for doubtful accounts is shown as a reduction from the gross accounts receivable. The net amount of accounts receivable is presented in a balance sheet. Accumulated amortization is an account similar to accumulated depreciation. This account only relates to a company’s intangible assets rather than tangible.

Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account. Treasure stock is a good example as it carries a debit balance and decreases the overall stockholders’ equity. 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.

How Contra Asset Accounts Work

In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. The discount on bonds payable amount shows the difference between the amount of cash received when issuing a bond and the value of the bond at maturity. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid).

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 deducted from the related Capital Assets to present the net balance on the parent account in a company’s balance sheet. 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. Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account.