What is a contra asset account?

In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. When a https://bookkeeping-reviews.com/ is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. A contra asset is a negative asset account that offsets the asset account with which it is paired.

If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.

What Is a Contra Account?

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• 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.
• If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming.
• We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
• By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
• The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.
• The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts.
• Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.

Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. 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.

Allowance for doubtful accounts

The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. 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. You’ll continue to use the https://bookkeeping-reviews.com/contra-asset-account/ until the equipment has been completely depreciated, retired, or sold. Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to.

Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. 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. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.

What is a Contra Asset?

Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset. Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. 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.

This type of account could be called the allowance for doubtful accounts or 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. 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. Contra equity reduces the total number of outstanding shares on the balance sheet.

Everything You Need To Master Financial Modeling

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. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000.

• In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question.
• Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.
• The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method.
• You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold.
• 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 balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.

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. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. 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.