Contra account What is a contra account?

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. 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. Contra asset accounts are necessary for companies for various reasons.

• The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company.
• The corresponding effect is charged to accumulated depreciation accounts.
• By recording reductions in a separate account, companies can get better insights into their actual accounts.
• This contra account holds a reserve, similar to the allowance for doubtful accounts.
• Although contra asset accounts have credit balances, they do not appear in liabilities or equity.
• By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.

Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense. For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. 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.

Contra Revenue 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. Similarly, it allows companies to retrieve original account balances without complicated calculations. For stakeholders, looking at both accounts is also crucial in their decision-making process.

Instead, the existence of contra asset accounts for companies will differ based on a company’s requirements. However, there are some prevalent contra asset accounts that may exist for all companies. A company’s financial accounts will usually have three types of items.

Types of Contra Accounts – Explanation

Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. 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.

This is done in order to separate data in these accounts for the analysis and presentation purposes. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written contra asset account near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement. The contra asset account carries a credit balance because an asset account usually has a debit balance.

Types of Contra 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. 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 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.

• 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.
• When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts.
• A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger.
• A contra account is a general ledger account with a balance that is the opposite of another, related account that it is paired with.
• A contra account is used in order to better portray the relationship between certain debits and credits within the overall financial structure of an entity.

The definition can be expanded to include contra accounts in general. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. A contra account is an account that is used to offset another account. The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of.

Why should one include contra accounts on a balance sheet?

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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. Understand what a balance sheet is, learn what a balance sheet shows, examine its format, and see an example of a balance sheet. The sales allowance shows the discounts given to customers when returning the product.

Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets. Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them. Although contra asset accounts have credit balances, they do not appear in liabilities or equity.

For example, Sales returns and allowances is a contra-revenue account, in which sales returns and allowances are separately accounted for in order to have a separate data for such items. There are many situations where one account is used to offset another account. One common example is accumulated amortisation, which is a contra-asset account. This means that it acts in the opposite manner of a regular asset account. In a balance sheet, accumulated depreciation would be reflected as a reduction from the asset’s account so that the net balance is evident.

It represents all the depreciation related to an asset or the company’s overall assets. Usually, companies add to the accumulated depreciation account after every accounting period. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently.