contra account definition and meaning

The credit balance of the contra liability account reduces the debit balance of the main asset account. The most common contra type, contra assets, records the loss in value of any asset accounts listed in your general ledger. And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business.

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. Accounts use this method of estimating the allowance to adhere to the matching principle.

How to Estimate the Allowance for Doubtful Accounts

This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. To oppose the revenue made by a company, contra revenue accounts must have a debit balance. Whenever the balance of a contra asset account increases (credit to the contra asset account), the increased amount is written off as an expense and is reported in the company’s income statement.

• Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
• Allowance for receivables is an account that companies maintain to record possible bad debts.
• In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed.
• The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.
• The amount of this reserve is typically based on the company’s historical loss experience for each reserve.

Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not straight line method formula due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000.

Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account.

What is a Contra Account?

Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. When a contra asset account is first recorded in a journal entry, the offset is to an expense.

What is a General Ledger Account?What is a General Ledger Account?

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. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid.

How to Use Contra Asset Accounts

Rather than pay this cost up-front and tie up a significant chunk of capital, Show-Fleur makes this purchase on credit with a 90-day due date after invoicing. Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings. Notes receivables are promissory notes that include a promise from a borrower to repay a lender. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.

Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances.

Consider an asset account, where the values are listed as debits, and the account itself will present a positive total. Conversely, for a contra asset account like depreciation, you would list all entries as a credit, carrying a negative total balance for the overall account. However, the “Allowance for Doubtful Accounts” (or “Allowance for Uncollectible Accounts”) is a contra account related to the concept of bad debts. This contra-asset account reduces the accounts receivable balance on the balance sheet to its net realizable value. The Allowance for Doubtful Accounts carries a credit balance that reduces the total amount of accounts receivable to show the amount that the company expects to collect. Overall, contra accounts are offsetting balances that are the opposite of specific accounts.

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. Contra assets are still recorded along with other assets, though their natural balance is opposite of assets. While assets have natural debit balances and increase with a debit, contra assets have natural credit balance and increase with a credit.