Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. 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. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account. This type of account could be called the allowance for doubtful accounts or bad debt reserve.

The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset.

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The accounting rules applicable to contra asset accounts are exactly opposite to asset accounts. Contra asset accounts are credited when these are increased and debited when these are decreased. There are generally two contra asset accounts used by companies that are an allowance for doubtful debts account and an accumulated depreciation account. Allowance for doubtful accounts is netted from the accounts receivable balance. The company predicts which accounts receivable won’t be paid by customers and writes those off.

Balance sheet, users of financial statements can learn more about the assets of a company. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. 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 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. All three values can be useful for investors depending on what they’re looking for.

How is a Contra Account Used?

When a good is sold on credit, the amount receivable from customers is shown under the debtor’s balance sheet balance. It is a standard business practice to prepare an estimate for the amount likely to go bad. This amount is shown as a provision or reserve for doubtful debts.

• Accumulated DepreciationThe accumulated depreciation of an asset is the amount of cumulative depreciation charged on the asset from its purchase date until the reporting date.
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• While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company.
• Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers.

When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account. If a company has a high or fast-growing allowance as a percentage of accounts https://www.wave-accounting.net/ receivable, keep a close eye on it. It could be growing with bad accounts, and cash flow will be affected. Taking into account the list of contra asset accounts, how would you calculate the net value of assets?

What Is a Contra Account & Why Is It Important?

If the example looks difficult, rest assured the solution is very simple. Because contra assets simply detract from the total value of the asset account, all one has to do is add up all the assets together first. Finally, take the total of depreciation and subtract it from total assets. If a ledger were to be observed in this situation, then one would see a balance of three asset debits matched up against three contra asset credits . When examining the term “contra asset account,” look no further than the root of contra to get a vague grasp of the definition. Because contra means “against,” one could quickly conclude that a contra asset account is going to be an account that goes against the regular asset account on the Balance Sheet. Quite frankly, the actual definition is not far from this estimate.

Contra EquityA contra equity account has a debit balance instead of a credit. 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.

Contra accounts have different names depending on the account they correspond. For instance, a contra account that relates to an accounts receivable is called a contra asset account. The same is true for other asset accounts like accounts receivable. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it.

• When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.
• Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.
• These contras reduce the equity account and carry a debit balance.
• These accounts are maintained individually and are adjusted from the corresponding asset’s balance to show the net amount of the assets in financial statements.
• Sales allowance represents discounts given to customers to entice them to keep products instead of returning them, such as with slightly defective items.

Accounts Receivable AccountAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year.

Depreciation Expense Account Vs. Allowance for a Depreciation Account

The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable. Now let’s focus our attention on the two most common contra assets – accumulated depreciation and allowance for doubtful accounts. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.