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. For this reason, contra accounts are primarily seen as having negative balances because Bookkeeping for attorneys they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. This type of account could be called the allowance for doubtful accounts or a bad debt reserve.
Hopefully, you have a pretty clear idea of contra asset meaning—no need to ask to define https://business-accounting.net/law-firm-bookkeeping-101/s anymore. Including contra asset accounts on your balance sheets can be hugely beneficial for your business. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
Is a Contra Balance Negative or Positive?
Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950.
The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable. 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. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements.
Reasons to include contra asset accounts on a balance sheet
Suppose a clothing business has sold $50,000 of inventory on credit. 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. The accounting entries for allowance for receivables are as follows. When researching companies, the financial statement is a great place to start. You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount.
Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for. This type of contra asset accounts is used for recording the depreciation within the timeframe of a fixed asset. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired.
Obsolete Inventory
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. 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. The company’s contra asset account will record unusable or obsolete assets. Assets can become obsolete or unusable for a variety of reasons, such as getting sold or retired because of wear or inefficiency.
Contra asset accounts also help companies keep their general ledgers organized. By recording reductions in a separate account, companies can get better insights into their actual accounts. As mentioned, companies do not represent these accounts on the balance sheet. However, they will still appear on the notes to the financial statements with necessary disclosures. Contra asset accounts help companies record any reductions to their non-current and current assets.
Understanding a Contra Account
Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000. If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries. Note that in accounting, the term “book value” is also used interchangeably with net value. Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired.
- Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory.
- Contra assets may be stated in separate line items on the balance sheet.
- A separate account is needed whenever the nature of transactions changes.
- Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance.
- By stating this information separately in a contra asset account, a user of financial information can see the extent to which a paired asset should be reduced.
- The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method.