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What Is A Contra Account & Why Is It Important?

A key example of contra liabilities include discount on notes or bonds payable. An accumulated depreciation account is a type of contra asset account that is used for recording the amount of depreciation a fixed asset evolves through.

“Daybooks” or journals are used to list every single transaction that took place during the day, and the list is totalled at the end of the day. These daybooks are not part of the double-entry bookkeeping system. The information recorded classified balance sheet in these daybooks is then transferred to the general ledgers. Not every single transaction needs to be entered into a T-account; usually only the sum of the book transactions for the day is entered in the general ledger.

Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit. Accumulated Depreciation contra account contains the cumulative sum total of all the depreciation expenses that have been charged against those fixed assets over time. You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity. Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account. Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased.

So, if the company reported receivables amounting to $100,000, the estimated 5% default rate would reduce the number of accounts receivable by $5,000. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. You could use that section or any asset account you create can go negative. AssetDebits Credits XThe “X” in the debit column denotes the increasing effect of a transaction on the asset account balance , because a debit to an asset account is an increase.

Is Accounts Payable An Asset?

This type of contra asset account may generally be debited expenses, followed by a credit to the company’s contra asset account for recording unusable inventory. Similarly, a business may also write off these types of expenses from its financial records if the inventory has been completely phased out.

When one institution borrows from another for a period of time, the ledger of the borrowing institution categorises the argument under liability accounts. Each transaction that takes place within the business will consist of at least one debit to a specific account and at least one credit to another specific account. A debit to one account can be balanced by more than one credit to other accounts, and vice versa. For all transactions, the total debits must be equal to the total credits and therefore balance. The Equity section of the balance sheet typically shows the value of any outstanding shares that have been issued by the company as well as its earnings. All Income and expense accounts are summarized in the Equity Section in one line on the balance sheet called Retained Earnings.

Examples of contra equity accounts include the treasury stock account, the owners’ drawing account, and a dividend account. The payment of cash to existing owners is a distribution which increases the contra equity account dubbed “treasury stock account”. An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable. The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers.

Contra Liability Account

If the credit is due to a bill payment, then the utility will add the money to its own cash account, which is a debit because the account is another Asset. Again, the customer views the credit as an increase in the customer’s own money and does not see the other side of the transaction.

The book value of an asset is the value of the asset recorded in the company’s balance sheet. Contra accounts are needed for determining the book value of assets held by a company. For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset. When the amount recorded in the contra revenue accounts is subtracted from the amount of gross revenue, it equals the net revenue of a company. In case a customer returns a product, the company will record the financial activity under the sales return account. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced.

Definition Of Contra Asset Account

In the event that a contra account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult. While tracking contra asset accounts is cumbersome for bookkeepers and accounting clerks using manual accounting systems, if you’re using accounting software you’ll find that most of the heavy lifting is done for you. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet.

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. Similarly, the company may choose to combine the amounts in both its contra and fixed asset accounts if the contra asset account has a relatively low balance.

Current assets are important to businesses because they can be used to fund day-to-day business operations and to pay for the ongoing operating expenses. Depreciation Expense is a temporary account since it is an income statement account. Accumulated Depreciation is a contra asset account and its balance is not closed at the end of each accounting period. As a result, Accumulated Depreciation is a viewed as a permanent account.

The amount on the equity contra account is deducted from the value of the total number of outstanding shares listed on a company’s balance sheet. The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement. Accounting Periods and Methodss provide business owners with the true value of certain asset accounts. For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. Revenue AccountRevenue accounts are those that report the business’s income and thus have credit balances. Revenue from sales, revenue from rental income, revenue from interest income, are it’s common examples.

How Do You Record An Asset?

Such accounts are allowance for doubtful accounts and the accumulated depreciation account. Contra accounts appear on the same financial statement as the related account. For example, an accounts receivable’s contra account is a contra asset account.

A contra asset is a negative asset account that offsets the balance in the asset account with which it is paired. In accrual-basis accounting, recording the allowance for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time. In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses. Contra account is important as it not only allows a company to report the original amount of a transaction but also report any reductions that may have happened so that the net amount will also be reported. They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value.

Contra Asset Account Definition

Key examples of unearned revenues include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset. The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. These are both asset accounts and do not increase or decrease a company’s balance sheet. Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Therefore, a contra asset can be regarded as a negative asset account.

This account, in general, reflects the cumulative profit or loss of the company. Sometimes, the same person may be a debtor as well as a creditor for the business.

• Designed for freelancers and small business owners, Debitoor invoicing software makes it quick and easy to issue professional invoices and manage your business finances.
• Debit balances are normal for asset and expense accounts, and credit balances are normal for liability, equity and revenue accounts.
• That being said, unearned rent does not remain a liability forever.
• The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers.
• Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and other liquid assets.

Contra Asset AccountA contra asset account is an asset account with a credit balance related to one of the assets with a debit balance. When we add the balances of these two assets, we will get the net book value or carrying value of the assets having a debit balance. The complete accounting equation based on the modern approach is very easy to remember if you focus on Assets, Expenses, Costs, Dividends . Conversely, a decrease to any of those accounts is a credit or right side entry.

Contra Asset Account Example

However, if you sell items that quickly become obsolete, such as consumable products with an expiration date or electronics that become quickly outdated, using the allowance for obsolete inventory is a must. If you stock a limited amount of inventory, you could probably do without it. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete.

These accounts can be listed based on the respective asset, liability, or equity account to reduce their original balance. The totals show the net effect on the accounting equation and the double-entry principle, where the transactions are balanced. Equity accounts record the claims of the owners of the business/entity to the assets of that business/entity.Capital, retained earnings, drawings, common stock, accumulated funds, etc. Contra revenue account, which is used to record the net amounts and usually has a debit balance, as opposed to the revenue account that records the gross amounts. If you are not using the reconciliation feature to record finance charges and fees then include a second GL Account number for your credit card fees expense account. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account. Long-Term Assets are parent accounts that contain the original acquisition cost of fixed assets.

Understanding A Contra Account

An example would be a contra liability account which would be debited to offset a regular liability account. A contra account is used in order to better portray the relationship between certain debits and credits within the overall financial structure of an entity. A contra account can be used to remedy an error, to track depreciation of an asset, or to register payments that are not collectible. The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible. The balance sheet shows the amount in the asset section underneath the accounts receivable.

In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet. More specifically, record the contra asset as a credit that is supposed to balance out a correlating plant asset.

Author: Wyeatt Massey

Categories: Bookkeeping

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