Contra Account Definition + Journal Entry Examples

You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. 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. At the end of year 20, the car and the accumulated depreciation accounts will be written off from the balance sheet, as the car will be a fully depreciated asset. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.

  1. Therefore, the allowance is created mainly so the expense can be recorded in the same period revenue is earned.
  2. A contra-asset account is an account that opposes the balances of other asset accounts.
  3. Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings.

Of the $50,000 balance that was written off, the company is notified that they will receive $35,000. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Master accounting topics that pose a particular challenge to finance professionals. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. NOW CFO is a “roll-up our sleeves” full service consulting firm with a singular focus on outsourced CFO, Controller, accounting, and finance needs.

This account offsets the balance in the respective asset account that they pair with on the balance sheet. The second method of estimating the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group. The aggregate of all group results is the estimated uncollectible amount. The net of the asset and its related https://business-accounting.net/ is referred to as the asset’s book value or carrying value. The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet.

However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. 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.

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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100.

In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. 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. If the bond is sold at a discount, the company will record the cash received from the bond sale as “cash”, and will offset the discount in the contra liability account. The Depreciation Expense account will show up on the income statement and will reduce the net income for the year by $1,000. The Accumulated Depreciation account is a contra asset account on the balance sheet that accumulates the total depreciation of the equipment over time.

Hence, the company will have gross revenue or net sales equal to $9,900. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart.

Understanding Contra Accounts

Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations. Allowance for receivables is an account that companies maintain to record possible bad debts. However, there are some prevalent contra-asset accounts that may exist for all companies.

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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. 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. The need for a contra asset account depends on the nature of the business and the types of transactions it engages in.

How to Account for the Allowance for Doubtful Accounts

As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account. But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss. In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account. 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.

Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. 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. A contra account is used to show the opposite effect or reduction of a related account.

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. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. Accumulated depreciation is the most prevalent type of contra-asset account. It represents all the depreciation related to an asset or the company’s overall assets.

Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet. This type of account is a contra asset that reduces the amount of the gross accounts receivable account. If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. The contra asset account, accumulated depreciation, is always a credit balance.

In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. 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.

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