A Beginner’s Guide to Using Contra Asset Accounts

In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels. Each of these has a unique purpose, but all are used to reduce the value of an asset on the balance sheet. The accounting entries for accumulated amortization are as follows. Get instant access to video lessons taught by experienced investment bankers.

  • The contra asset account, accumulated depreciation, is always a credit balance.
  • The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable.
  • Every contra asset account on a company’s accounting records will also have a pairing account.
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  • While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company.

These are all examples of contra asset accounts, which are the prevalent type of contra accounts. There are three contra asset accounts that commonly appear in an organization’s chart of accounts. It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive.

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To oppose the revenue made by a company, contra revenue accounts must have a debit balance. This account appears next to the current asset Accounts Receivable. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. The use of Allowance https://personal-accounting.org/completed-contract-method-of-revenue-recognition/ 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.

  • Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.
  • Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.
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  • 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.

The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts). The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. A liability that is recorded as a debit balance is used to decrease the balance of a liability.

Contra revenue account

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. For example, a bond with a principal amount of $1,000 may be sold for only $950. The bond is listed on the balance contra asset meaning sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000.

Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. Another question that we get is what is the relationship between a contra asset balance and the book value. Investopedia notes that the difference between the asset’s contra account balance and its account balance is called the book value. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. 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.

What is a contra asset account?

This type of accounts involves the products or goods of a company that is now unusable or obsolete. The two most common examples of contra asset accounts are the accumulated depreciation contra account, and the allowance for doubtful debts contra account. Accumulated depreciation is the contra asset account used to reduce the value of a fixed asset, such as a building or machinery, over its estimated useful life.

Note that in accounting, the term “book value” is also used interchangeably with net value. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods.

Contra Revenue Account

Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for. In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account. In other words, the contra liability account is used to adjust the book value of an asset or liability.