There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
Asset accounts usually have a positive value which is the same as a debit balance. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. 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.
Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. This type of account could be called the allowance for doubtful accounts or a 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 accumulated depreciation account is perhaps the most common contra asset account used by business owners. Setting up contra asset accounts is easy with accounting software. A bit more work will be required on the accountant’s or account analyst’s behalf if books are done manually without any software. Contra asset accounts are asset accounts where the balance is a credit balance.
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. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. By reading these financial statements, an individual will see the full financial picture of the company in question. It is critical that companies estimate their allowance for bad debt correctly; otherwise, the resulting expected future revenue will be incorrect. 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.
Examples of Contra Accounts
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. 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.
- The definition can be expanded to include contra accounts in general.
- Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services.
- Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement.
- As the term suggests, it is the credit balance of a specific asset since assets are usually under debit accounts.
- By doing so, they can bring their asset accounts to a more accurate position.
- When a company repurchases shares, it increases the fractional ownership of all remaining shareholders.
The amount is reported on the balance sheet in the asset section immediately below accounts receivable. The net of these two figures is typically reported on a third line. 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.
Contra Asset Journal Entry Accounting
Though the Pareto Analysis can not be used on its own, it can be used to weigh accounts receivable estimates differently. For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism. Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk. In this example, the company often assigns a percentage to each classification of debt. Then, it aggregates all receivables in each grouping, calculates each group by the percentage, and records an allowance equal to the aggregate of all products.
What Are the Different Types of Contra Accounts?
In accounting, assets are things of value that your business owns. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Contra asset accounts are, as the name implies, accounts that are contrary to popular belief. 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. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds.
Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated. The main how long should you keep business records reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. Contra liability accounts are not as popular as contra asset accounts. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation.
How to Use Contra Asset Accounts
The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period. The equity section of the balance sheet is where the shareholder’s claims to assets are reported.
When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. A liability that is recorded as a debit balance is used to decrease the balance of a liability.
Accounts Receivable is an asset account that represents the amount of money due to a business for goods or services that have been delivered or used but not yet paid for by customers. 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.
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. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
The company can recover the account by reversing the entry above to reinstate the accounts receivable balance and the corresponding allowance for the doubtful account balance. Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases. A company can further adjust the balance by following the entry under the « Adjusting the Allowance » section above.
For example, after six years, the asset’s book value on the balance sheet will be $40,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account. This requirement also comes from the accounting standard for inventories. Allowance for receivables is an account that companies maintain to record possible bad debts. However, this account does not represent actual irrecoverable debts.
