Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. 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. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.
Contra Asset Accounting & Examples
Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Note that accountants use contra accounts rather than reduce the value of the original account directly https://www.kelleysbookkeeping.com/ to keep financial accounting records clean. In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance. The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
Contra Account Definition, Types, and Example
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 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.
Types of contra accounts
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. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts).
Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts. In other words, contra accounts are used to reduce normal accounts on the balance sheet. 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. The difference between an asset’s account balance and the contra account balance is known as the book value.
In spite of its name, contra liabilities function more similarly to assets. In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of how to do accounting transactions January 31, 2021.” 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.
- Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value.
- The difference between an asset’s balance and the contra account asset balance is the book value.
- Suppose a bond is issued at a discounted price – i.e. lower than the redemption price (or the stated “par value”).
- Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
- Master accounting topics that pose a particular challenge to finance professionals.
Offsetting the asset account with its respective contra asset account shows the net balance of that asset. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account.
The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.
Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. Companies that issue bonds are likely to use contra liability accounts. If the bond is sold at a discount, the company will record the cash received from the bond sale as “cash”, and will offset the discount in the contra liability account. 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.
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. The reason financing fees are an example of a contra https://www.kelleysbookkeeping.com/online-medical-billing-and-coding-voucher-included/ liability is that the fees – much like interest on the debt – are amortized over the debt borrowing term. The B/S impact is where the contra liability comes into play, i.e. the historical value of the debt is not impacted by the OID.
Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950. The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings.
In other words, the contra liability account is used to adjust the book value of an asset or liability. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find. Companies bury them in the footnotes and often don’t break out the actual calculation. Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. Allowance for doubtful accounts is netted from the accounts receivable balance. The company predicts which accounts receivable won’t be paid by customers and writes those off.