The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance. Also, note that when writing off the specific account, no income statement accounts are used. This is because the expense was already taken when creating or adjusting the allowance. Properly documenting these contra accounts in your ledger can sometimes feel counter-intuitive since they operate in an opposite manner from their parent accounts.
- Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance.
- The initial cost of this upgrade was $8 thousand per limo or $600,000 in total.
- 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.
- The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts.
The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate. Let us assume that an organization has fixed assets in the amount of 300 thousand.
Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance. Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue.
Allowance for Receivables
That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. 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.
- This type of account could be called the allowance for doubtful accounts or a bad debt reserve.
- Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance.
- Contra liability, equity, and revenue accounts have natural debit balances.
- 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.
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. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
Definition and Examples of Contra Assets
Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset. 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.
Prime Account Detected!
In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels.
For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. 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. Whenever the balance of an allowance for doubtful accounts account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. The difference between an asset’s account balance and the contra account balance is known as the book value.
A Pareto analysis is a risk measurement approach that states that a majority of activity is often concentrated among a small amount of accounts. In many different aspects of business, a rough estimation is that 80% of account receivable balances are made up of a small concentration (i.e. 20%) of vendors. 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.
For example, based on previous experience, a company may expect that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense. 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. In its general ledger, the business will want to capture its gross sales figures and the actual value of the discount. A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset. To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together.