What Is a Contra Account? Types + Examples
At the end of year 20, the car and the accumulated depreciation accounts will be written off from the balance sheet, as the car will be a fully depreciated asset. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. Contra asset accounts 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. Contra account balances do decrease balances of the main accounts and then the net balance is reported in the financial statements. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity).
- Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month.
- Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.
- By offsetting the balance of a related account, contra accounts help to ensure that the financial statements are not overstated.
- But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss.
- 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.
Accounting software can simplify the management of and reporting from your ledger. With the appropriate level of automation integration in your chosen tool, you can pull the relevant values into these individual accounts directly from invoices, credit agreements, and other documentation. In this article, we’re going on a deep dive into what exactly a contra account is, how contra accounts work, why and how you would use contra accounts and more. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling. Contra revenue account is an opposite account to revenue, which decreased gross revenue balance and the result is called net revenue. 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 January 31, 2021. »
Why should one include contra accounts on a 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.
Contra Accounts
Contra accounts act like regular accounts on the balance sheet but have a unique purpose. 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. Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. This discount is subtracted from the total amount borrowed to better reflect the discount given by the lender. In this way, an accumulated amortisation account offsets a related asset account (which is recorded as a debit).
Understanding a Contra Account
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. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory.
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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. Go a level deeper with us and investigate the potential impacts of climate change on investments like your retirement account. These accounts have to be closed at the end of the accounts period in the same way as the main Income Statement accounts are being closed. Home Depot also devotes footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation.
Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes. 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.
However, these vehicles have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 contra asset accounts thousand, meaning the depreciation per vehicle is $100 thousand. This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated.
Most accounts receivable would just be the time between purchase and credit card settlement. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative. On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead.
They are used in case some customers won’t be able to pay the money they owe to the business. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position. This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability.
Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. 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.
There are three https://business-accounting.net/ that commonly appear in an organization’s chart of accounts. It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry.
