Contra Accounts Examples & How They Work

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. The equity section of the balance sheet is where the shareholder’s claims to assets are reported. The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company.

Before we start talking about the finer details, it’s important to know what is a contra asset account. For example, it is not very useful to show the PPE cost account and the related accumulated depreciation account separately on the balance sheet. We are better off subtracting the accumulated depreciation account (the contra account) from PPE cost account (the parent account) to arrive at the net balance of the PPE. In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900.

A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported. The net amount is often referred to as the carrying amount or perhaps the net realizable amount. In the financial statements the asset a/c would be offset against the contra asset a/c to show the net balance. This will repeat until the machinery has been totally depreciated, sold, or retired.

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• The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value.
• 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.
• If this occurs, the company will debit the allowance for doubtful accounts and credit the corresponding receivables account.

This account appears next to the current asset Accounts Receivable. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. 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. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. 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.

It is critical that companies estimate their allowance for bad debt correctly; otherwise, the resulting expected future revenue will be incorrect. In the above example, the debit to the contra liability account of $100 purchase assets in accounting lets the company recognize that the bond was sold at a discount. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.

What Is a Contra Asset?

Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. An account with a balance that is the opposite of the normal balance. For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account.

• Allowance for doubtful accounts is netted from the accounts receivable balance.
• This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.
• Obsolete inventory or obsolete inventory reserves is another popular type of contra asset accounts.
• The equity section of the balance sheet is where the shareholder’s claims to assets are reported.

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. When researching companies, the financial statement is a great place to start.

A final word about contra asset accounts

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. 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. 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. Hopefully, you have a pretty clear idea of contra asset meaning—no need to ask to define contra asset accounts anymore. Including contra asset accounts on your balance sheets can be hugely beneficial for your business.

When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. 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. In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory.

What is Contra Account?

For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000. 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. Note that in accounting, the term “book value” is also used interchangeably with net value.

An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. Even small businesses benefit immensely from contra asset accounts. 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.

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. Contra equity reduces the total number of outstanding shares on the balance sheet.

Allowance for doubtful accounts

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. 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.

Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Suppose a clothing business has sold $50,000 of inventory on credit. 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.

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. Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are.

Most accounts receivable would just be the time between purchase and credit card settlement. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. As evident from the table below, each contra account has a parent account whose normal balance is often exactly opposite of the normal balance of the relevant contra account.

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. Therefore, the asset’s net value (or the book value) will be $70,000. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative.