Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. 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. The contra equity account treasury stock is reported right on the balance sheet.
An entry will be recorded on the credit side if and when a debit entry is recorded in an account and vice-versa. 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. Rather, it is an adjunct account or a valuation account that is added to the face value of the bonds to arrive at the carrying value (or book value) of the bonds on the balance sheet. Any company that owns intangible assets such as software, patents, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. Accumulated amortization is an account similar to accumulated depreciation.
What Is the Benefit of Using a Contra Account?
To oppose the revenue made by a company, contra revenue accounts must have a debit balance. The importance of contra asset accounts is generally to reduce the value of some related account. The contra asset account pulls the value of the combined accounts down, which in turn decreases the value of the second account as well, which is a normal account. Role of Financial Management in Law Firm Success Contra assets may be stated in separate line items on the balance sheet. 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 first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds.
Everything You Need To Build Your Accounting Skills
Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com. The money left over after a company supports operations can be a snapshot of its financial health. Contra accounts https://turbo-tax.org/law-firm-accounting-bookkeeping-service-reviews/ are confusing at first, but, with a little study, understanding them becomes second nature. Let’s go over how they work and what the main types are, and then finish with an example. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.
- A bit more work will be required on the accountant’s or account analyst’s behalf if books are done manually without any software.
- The allowance for these doubtful accounts can ultimately result in the total number of receivables.
- Other examples include (1) the allowance for doubtful accounts, (2) discount on bonds payable, (3) sales returns and allowances, and (4) sales discounts.
- Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.
- They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting.
- The net amount is often referred to as the carrying amount or perhaps the net realizable amount.
If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. 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. These contras reduce the equity account and carry a debit balance. Contra equity reduces the total number of outstanding shares on the balance sheet.
Types of Contra Accounts – Explanation
This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated. The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback.
- Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.
- Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value.
- A contra account is an account with a balance opposite the normal accounts in its category.
- The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables.
- The company predicts which accounts receivable won’t be paid by customers and writes those off.
The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. 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.
Contra accounts definition
For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances. A separate account used in such a situation is sometimes called a adjunct account. In an accounting system, ledger accounts are designed to contain only similar transactions and/or balances. A separate account is needed whenever the nature of transactions changes.
It is because clubbing together dissimilar transactions impedes any analysis. For example, we need separate accounts to hold the actual cost of property, plant and equipment (PPE) and related accumulated depreciation. If we record depreciation expense in the cost accounts directly, we will lose key information about the original cost of the assets and accumulated depreciation. To avoid this loss of important data, we record actual cost and depreciation in separate ledger accounts.