Contra Asset: What It Is and How a Contra Asset Account Works

By doing so, they can bring their asset accounts to a more accurate position. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. Instead, the existence of contra-asset accounts for companies will differ based on a company’s requirements. For example, if an account has a debit balance, a contra account will have a credit balance.

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.

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. 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. The sales method applies a flat percentage to the total dollar amount of sales for the period.

  • The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
  • Therefore, contra-asset accounts differ from other accounts that have a credit balance.
  • Instead of applying percentages or weights, it may simply aggregate the account balance for all 11 customers and use that figure as the allowance amount.
  • Accumulated depreciation reflects the reduction in value of a fixed asset.

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Specific Identification Method

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Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired. Instead of increasing assets or decreasing liabilities (as would be typical when spending cash), buying treasury stock reduces shareholders’ equity. Specifically, it is contra to shareholders’ equity because it decreases the total shareholders’ equity on the balance sheet. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance. Both of these accounts offset each other to represent a net balance on a company’s balance sheet.

Adjusting the Allowance

Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. When asked what he meant by “achieve the number,” Cohen responded, “Whatever number Mr. Trump told us” for his desired net worth. For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding. Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible.

Usually, companies add to the accumulated depreciation account after every accounting period. Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them. 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.

AccountingTools

The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. This will repeat until the machinery has been totally depreciated, sold, or retired. At the end of year 20, the car and the accumulated depreciation accounts how to deduct personal appearance expenses will be written off from the balance sheet, as the car will be a fully depreciated asset. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. The definition can be expanded to include contra accounts in general.

Contra Asset Journal Entry Accounting

Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability. A contra asset account is an account in the balance sheet that offsets the balance of a regular asset account. A less common example of a contra asset account is Discount on Notes Receivable.

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. Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers.

Regardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account.

If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries. Note that in accounting, the term “book value” is also used interchangeably with net value. 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. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.

Contra

You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. The second entry will be accumulated depreciation, which will be in credit. Contra asset accounts are reported with the related account on the same financial statement. 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. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.

Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. 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.

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. A contra account carries a balance that is opposite to the normal balance of its related main account. Accumulated amortization is an account similar to accumulated depreciation. This account only relates to a company’s intangible assets rather than tangible.