What Is a Contra Asset?

The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. Put that contra asset accounts are accounts presented as deductions from the overall value of a particular asset. As the term suggests, it is the credit balance of a specific asset since assets are usually under debit accounts. Hence, it is called contra since credit balance is a counterpart or coordinate of the debit balance of an asset.

• This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet.
• If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense.
• The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount.
• For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due.

Contra asset accounts are necessary for companies for various reasons. The most prominent of these include allowing companies to present a more accurate picture of their assets. On the other hand, accumulated depreciation is a contra-asset account. However, there are some prevalent contra-asset accounts that may exist for all companies. 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.

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. Contra asset accounts are asset accounts where the balance is a credit balance. They are called “contra” asset accounts because these accounts are contrary to normal accounts. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory.

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Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining. A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts).

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. The account offsets the balance in the respective asset account that it is paired with on the balance sheet. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. Contra assets may be stated in separate line items on the balance sheet. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet.

• The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account.
• Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately.
• For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets.
• However, they will still appear on the notes to the financial statements with necessary disclosures.
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• Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory.

When researching companies, the financial statement is a great place to start. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete. This improvement in the accounting details and transparency is good for any business in multiple ways. These accounts might also appear on the balance sheets of the company.

This account appears next to the current asset Accounts Receivable. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers.

Including contra asset accounts on your balance sheets can be hugely beneficial for your business. The importance of contra asset accounts is generally to reduce the value of some related account. The contra asset account pulls the value of the combined accounts down, which in turn decreases the value of the second account as well, which is a normal account. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. A customer returned $100 worth of items, claiming them to be defective. 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.

Companies that hold inventories for a long time may face accumulating obsolete inventory. The accounting entries for allowance for receivables are as follows. The accounting entries for accumulated depreciation are as follows. If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee.

Obsolete Inventory

This account offsets the balance in the respective asset account that they pair with on the balance sheet. If the company is certain that they will not receive this money, they can reduce the value of the relevant asset. If this occurs, the company will debit the allowance for doubtful accounts and credit the corresponding receivables account. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance.

Contra asset accounts have a credit balance as compared to a debit balance that most other types of accounts have. Before we start talking about the finer details, it’s important to know what is a contra asset account. To oppose the revenue made by a company, contra revenue accounts must have a debit balance.

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The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable. They are used in case some customers won’t be able to pay the money they owe to the business. 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. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account.

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The amount is not reported, and the net sales amount is reported on the income statement. 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. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. 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.

Accumulated depreciation

There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These are all examples of contra-asset accounts, which are the prevalent type of contra accounts. Allowance for doubtful accounts is netted from the accounts receivable balance.

For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. The natural balance of a contra asset account, in this case, is exactly the opposite of the balance of the related account.

Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance accounting cycle steps explained 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.