Contra accounts definition
Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. A contra asset account is a type of counter account that is used to adjust the debit balance of the main asset account. The contra asset account is considered only in interaction with the main active account, and the latter can only be an asset, and the regulating contract account – liabilities.
- The difference between an asset’s balance and the contra account asset balance is the book value.
- For example, a building costs 30-million upon initial purchase, and it is estimated to last for 30 years.
- Note that in accounting, the term “book value” is also used interchangeably with net value.
- If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.
- Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense.
A company uses this account to record how many accounts receivable it thinks will be lost. Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet. This type of account is a contra asset that reduces the amount of the gross accounts receivable account. Therefore, contra-asset accounts differ from other accounts that have a credit balance. 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.
Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them. Although contra-asset accounts have credit balances, they do not appear in liabilities or equity.
This means that this person is not capable of paying the borrowed 1,000. Thus, the lender only has 4,000 collectibles as the remaining 1,000 is filed under allowance of doubtful accounts. 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). Accounting software can simplify the management of and reporting from your ledger.
Companies often have a specific method of identifying the companies that it wants to include and the companies it wants to exclude. Because the allowance for doubtful accounts is established in the same accounting period as the original sale, an entity does not know for certain which exact receivables will be paid and which will default. Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must be established in the same accounting period as the sale, but can be based on an anticipated or estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account.
Example of a Contra Account
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. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. The following are examples of commonly-used contra asset accounts you could create to better understand your business financials. However, it’s important to keep in mind that you can create any contra account you want to more clearly describe your business — this is not an exhaustive or definitive list. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method.
Free Financial Statements Cheat Sheet
As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts.
The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. To compensate for those potential quickbooks online review deadbeat customers, you can use a Bad Debts account to serve as a contra for your A/R. If the company is certain that they will not receive this money, they can reduce the value of the relevant asset.
And when your business still has some of these outdated, unwanted, or unusable items in your inventory, you’ll want to offset the lost value of these assets in your general ledger and balance sheet. So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance. Both of these accounts offset each other to represent a net balance on a company’s balance sheet. 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. Management may disclose its method of estimating the allowance for doubtful accounts in its notes to the financial statements.