What is a Contra Asset Account

The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). 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 they are used to reduce the balance of another account.

What is a Contra Asset Account

For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. A contra asset is a negative asset account that offsets the asset account with which it is paired. The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. 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.

Is a Contra Balances Negative or Positive?

INVESTMENT BANKING RESOURCESLearn the foundation of Investment banking, financial modeling, valuations and more. So, an organization looking for a robust accounting process must move to this reporting for better understanding. Are retail accounting prepared for various parties; some of them might not be accounting versed; they help identify the reduction in total value. Provision for a discount from creditors and discount on bills receivable are other widely used examples.

  • Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue.
  • When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account.
  • The netbook value of the machinery by the end of the first year will be $80,000 ($100,000-$20,000) and $60,000 ($100,000-$40,000) by the end of the second year.
  • In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory.

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Contra Liability Account

The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers. If actual experience differs, then management adjusts its estimation methodology to bring the reserve more into alignment with actual results. The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement. 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. Another reason to include contra accounts on a balance sheet is to preserve the historical value of the main account.

In this method, bad debt expense is estimated for the period and is recorded as an expense while the allowance account is credited. For example, if the balance of accumulated depreciation increases from $20,000 to $50,000, this means that the depreciation expense amounts to $30,000, which will be listed in the income statement. Sometimes, both accounts can be written in a single line if they don't represent a large portion of the assets. In case the CA 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. Both the asset and the corresponding CA accounts must be stated clearly in the balance sheet.

Overview of contra accounts

They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. 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. A contra asset account is an asset account with a natural credit balance. This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.

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