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. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid). A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
- When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account.
- Let’s consider the above example of machinery, if it is reported at net value (after reducing depreciation), user may not in a position to know the purchase cost of the of machinery; how much depreciation is written off etc.
- Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost.
- If you’re using the wrong credit or debit card, it could be costing you serious money.
- This type of account could be called the allowance for doubtful accounts or a bad debt reserve.
- In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000.
He has written publications for FEE, the Mises Institute, and many others. Contra accounts help provide more accurate financial information by separating certain items and highlighting their impact on the overall financial position. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.
Example Contra Account – Allowance for Doubtful Accounts
With contra equity accounts, you reduce the number of outstanding shares you list on your company’s balance sheet. Treasury stock and owner’s drawing account are examples of contra equity accounts. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position. This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability. The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense.
Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet. Anytime you need to depreciate an asset, you’ll use an accumulated depreciation contra asset account, which records the amount of depreciation that has been expensed while offsetting the value of the asset being depreciated. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet.
For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts. The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
If you debit the contra account, ensure that you offset the related account with a credit balance. In essence, contra accounts allow you to report your firm’s gross and net amounts. These accounts also ensure that you follow the matching principle in accounting, which states that you record expenses in the same period you incur them.
By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. Creating allowances for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect.
Why Use a Contra Account?
Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. If you’re still using manual accounting systems, you’ll need to do a bit more work by recording your accumulated depreciation expense in your general ledger while also reporting it on your balance sheet as a contra asset account.
Equity Contra Account
If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it. A second example of a contra asset account is Accumulated Depreciation. Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. The what is a common stock learn the basics the motley fool in the balance sheet help the users of the financial statement to get complete information.
Given that liabilities have a credit balance, ensure that all your contra liabilities accounts have debit balances. Discount on notes payable and discount on bonds are examples of contra liability accounts. If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements. This depreciation is saved in a contra asset account called accumulated depreciation.
Meaning of contra account in English
Examples of revenue contra accounts are Sales Discounts, Returns and Allowances. Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.
Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet. Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance. A contra liability is a general ledger account with a debit balance that reduces the normal credit balance of a standard liability account to present the net value on a balance sheet. Examples of contra liabilities are Discounts on Bonds and Notes Payable and Short-Term Portion of Long-Term Debt. In response, the firm should decrease its accounts receivable and revenue balances.
What is a contra account?
If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. 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. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete.
