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What is a Contra Asset Account? Definition, Types, Example, and More

Most accounts receivable would just be the time between purchase and credit card settlement. As mentioned, companies do not represent these accounts on the balance sheet. However, they will still appear on the notes to the financial statements with necessary disclosures. On the other hand, accumulated depreciation is a contra-asset account.

  • Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.
  • On the other hand, accumulated depreciation is a contra-asset account.
  • For stakeholders, looking at both accounts is also crucial in their decision-making process.
  • Thus, the natural balance of a contra account is always the opposite of the account with which it is paired.

Ultimately, an accumulated depreciation contra asset account helps the company reduce the gross amount of all the fixed assets within a company. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. Contra asset accounts are a type of contra account that net off against asset accounts.

Is Accounts Receivable a Contra Account?

For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism. Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk. In this example, the company often assigns a percentage to each classification of debt. Then, it aggregates all receivables in each grouping, calculates each group by the percentage, and records an allowance equal to the aggregate of all products.

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. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. The allowance for these doubtful accounts can ultimately result in the total number of receivables. ADAs are used to create allowances for clients that bought the company’s goods or services but somehow failed to pay the owed amount. This allows the financial analyst to evaluate the company inventory’s current market value. Businesses can also write off many expenses like these from the financial records even if the inventory has been phased out completely.

When researching companies, the financial statement is a great place to start. Notes receivables are promissory notes that include a promise from a borrower to repay a lender. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete.

That is to completely or partially offset the balance of their related asset accounts. Asset accounts usually have a positive value which is the same as a debit balance. 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.

Contra asset accounts have a credit balance as compared to a debit balance that most other types of accounts have. Before we start talking about the finer details, it’s important to know what is a contra asset account. In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900. Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet.

How to Use Contra Asset Accounts

However, there are some prevalent contra-asset accounts that may exist for all companies. A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance. Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance. Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.

Contra accounts 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.

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This account offsets the balance in the respective asset account that they pair with on the balance sheet. The difference between an asset’s account balance and the contra account balance is known as the book value. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. 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.

Why Do Accountants Use Allowance for Doubtful Accounts?

This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet. A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation.

These contras reduce the equity account and carry a debit balance. Contra equity reduces the total number of outstanding shares on the calculating the intrinsic value of preferred stocks balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.

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