contra asset account definition

For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. A debit will be made to the bad debt expense for $4,000 to balance the journal entry.

Is Accounts Receivable a Contra Account?

Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. Similarly, it allows companies to retrieve original account balances without complicated calculations. For stakeholders, looking at both accounts is also crucial in their decision-making process. Contra-assets provide stakeholders with a more nuanced understanding of the company’s true financial health by reflecting the deterioration or reduction in value of assets.

Presentation of Contra Assets

Accounts Receivable and Allowance for Doubtful AccountsA classic example of a contra asset account is the Allowance for Doubtful Accounts. This contra asset reduces the value of Accounts Receivable to reflect that some customers may not pay what they owe. For instance, if a company has $100,000 in Accounts Receivable, it may estimate that 5% will be uncollectible. It will then create an Allowance for Doubtful Accounts with a credit balance of $5,000, decreasing the net amount of receivables.

Understanding a Contra Account

This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.

How are contra asset accounts recorded in financial statements?

contra asset account definition

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). A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. 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.

contra asset account definition

Contra Account Definition, Types, and Example

  • Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet.
  • By doing so, you can more clearly see the total amount of the related asset account, which would otherwise have been obscured by the offsetting amount of the reserve.
  • Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.
  • A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation.

Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. When a contra asset account is first recorded in a journal entry, the offset is to an expense. 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. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable.

  • By nature, typical asset accounts possess a debit balance; however, contra asset accounts typically have a credit balance.
  • 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.
  • The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
  • This account offsets the balance in the respective asset account that they pair with on the balance sheet.
  • While a contra asset account offsets the balance of an asset, a contra revenue account offsets revenue.

Bookkeeping with Contra Asset Accounts

While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. There are three contra asset accounts that commonly appear in an organization’s chart of 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.

Categories: Bookkeeping