For example, GAAP accounting (or generally accepted accounting principles) requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for.
Obsolete Inventory
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. Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts. The dollar balance in the allowance for uncollectible accounts is the amount you don’t expect to collect, and this offsets the amount you report in accounts receivable.
What is Accounts Receivable Collection Period? (Definition, Formula, and Example)
Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. 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 contra asset account, accumulated depreciation, is always a credit balance.
Example of a Contra Account
- A contra account carries a balance that is opposite to the normal balance of its related main account.
- In other words, contra revenue is a deduction from gross revenue, which results in net revenue.
- The exact process can vary depending on the specific contra account and the accounting practices of the company.
- Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers.
The amount is reported on the balance sheet in the asset section immediately below accounts receivable. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability.
If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements. 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). 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.
Be sure to enter the contra account on the opposite column of the account they’re offsetting. If contra assets appear in the credit column, record contra liabilities on side. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value.
A contra account is an account used in a general ledger to reduce the value of a related account when the two are netted together. The term “contra” means “against,” which perfectly describes the role these accounts play in your finances – they are going against the norm. Any company that owns intangible assets such as software, patents, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets.
Is a Contra Balance Negative or Positive?
- Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.
- Note that if a company believes it may recover a portion of a balance, it can write off a portion of the account.
- As mentioned, a company will usually have debit balances in its asset accounts.
- These are all examples of contra-asset accounts, which are the prevalent type of contra accounts.
- Usually, companies add to the accumulated depreciation account after every accounting period.
- For example, GAAP accounting (or generally accepted accounting principles) requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used.
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. For example, if your business has accounts receivable of $50,000 and an allowance for doubtful debts account totalling $5,000, the net accounts receivable is $45,000. In this way, a contra asset (credit) lowers the overall value of your accounts receivables (debit) on the balance sheet.
How are Contra Accounts Used and Reported?
Of the $50,000 balance that was written off, the company is notified that they will receive $35,000. Master accounting topics that pose a particular challenge to finance professionals. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent, contra account a Motley Fool service, does not cover all offers on the market. This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders. Osman started his career as an investment banking analyst at Thomas Weisel Partners where he spent just over two years before moving into a growth equity investing role at Scale Venture Partners, focused on technology.
A contra liability is a general ledger account with a debit balance that reduces the normal credit balance of a standard liability account to present the net value on a balance sheet. Examples of contra liabilities are Discounts on Bonds and Notes Payable and Short-Term Portion of Long-Term Debt. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting.