Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds. Contra assets are still recorded along with other assets, though their natural balance is opposite of assets. While assets have natural debit balances and increase with a debit, contra assets have natural credit balance and increase with a credit. The contra liability account is less common than the contra asset account.

• Allowance for doubtful accounts is netted from the accounts receivable balance.
• A contra account provides missing context by pairing it with a related account.
• However, the actual payment behavior of customers may differ substantially from the estimate.
• And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business.
• However, the details for contra accounts usually exist on the notes to the financial statements.
• This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated.

What is a Contra Asset Account?

This requirement also comes from the accounting standard for inventories. 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. 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. Accounts use this method of estimating the allowance to adhere to the matching principle. The matching principle states that revenue and expenses must be recorded in the same period in which they occur. Therefore, the allowance is created mainly so the expense can be recorded in the same period revenue is earned.

• For the purpose of financial statement reporting, the amount on a contra account is subtracted from its parent account gross balance to present the net balance.
• In many different aspects of business, a rough estimation is that 80% of account receivable balances are made up of a small concentration (i.e. 20%) of vendors.
• 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.
• 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.
• By combining the balances in these two accounts, you can determine the net amount of receivables that the reporting entity expects to receive.

Contra Account Definition, Types, and Example

For example, if an account has a debit balance, a contra account will have a credit balance. Thus, netting off both will result in the final amount for the account. For the purpose of financial statement reporting, the amount on a contra account is subtracted from its parent account gross balance to present the net balance.

Presentation of Contra Asset Accounts

If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. For example, GAAP accounting (or generally accepted accounting principles) requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value.

Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. 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.

Conversely, for a contra asset account like depreciation, you would list all entries as a credit, carrying a negative total balance for the overall account. The most common contra type, contra assets, records the loss in value of any asset accounts listed in your general ledger. And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business. Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes. Contra asset accounts are a type of contra account that net off against asset accounts.

Allowance for doubtful accounts

There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. A contra-asset account is an account that opposes the balances of other asset accounts. As mentioned, a company will usually have debit balances in its asset accounts. Contra accounts are a significant part of a company’s financial statements. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement.

The Advantage of Using a Contra Asset Account

The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. 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. The list of asset accounts on your general ledger and balance sheet conveys the combined, potential value of all of the tangible and intangible items that your organization possesses.

Balance Sheet

Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. Allowance for doubtful accounts is contra what is a contra account 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.

• 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.
• Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.
• Most accounts receivable would just be the time between purchase and credit card settlement.
• The hottest retail item of today can be relegated to nostalgia channels on YouTube tomorrow.

Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts. In other words, contra accounts are used to reduce normal accounts on the balance sheet. 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.