A Contra liability account is an account that is used to offset another liability account on the balance sheet. Contra liability accounts are typically used for bonds, notes payable, and other indebtedness. An allowance for doubtful accounts is a contra asset account that is used to offset Accounts Receivable on the balance sheet. This account is used to estimate the amount of money that is not likely to be collected from customers.
What is a contra asset account?
Such information can be used in the future to try and collect on outstanding debt. Create a Journal where credit card fees & interest will be recorded during reconciliation. In other words, contra revenue is a deduction from gross revenue, which results in net revenue. Sage 50cloud is a feature-rich accounting platform with tools for sales tracking, reporting, invoicing and payment processing and vendor, customer and employee management. However, if you sell items that quickly become obsolete, such as consumable products with an expiration date or electronics that become quickly outdated, using the allowance for obsolete inventory is a must. When posting transactions, one would credit the contra asset account to increase its balance, which decreases the net value of the corresponding asset.
To reflect the reduction in the equipment’s value due to depreciation, the company also records $10,000 in the Accumulated Depreciation account. After one year, the Equipment account shows $40,000 ($50,000 – $10,000), and Accumulated Depreciation shows $10,000. These accounts are created specifically for the reason to be able to decrease the amount reflected in a corresponding account in an indirect way.
Contra Asset Account Definition
In addition, year-end accounts receivable total $100,000 but have an anticipated net realizable value of only $93,000. Neither the $7,000 nor the $93,000 figure is expected to be exact but the eventual amounts should not be materially different. This basic portrait provides decision makers with fairly presented information about the accounts receivables held by the reporting company. Before the advent of computerised accounting, contra asset meaning manual accounting procedure used a ledger book for each T-account. Totaling of all debits and credits in the general ledger at the end of a financial period is known as trial balance.
A Contra Asset Account is an asset account having a credit balance that is related to one of the assets with a debit balance. When we add the balances of two of these assets together, it reflects the net book value or carrying value of the debit balance assets. The main advantage of using a contra asset account is to separate this reduction from the asset account with which it is paired. By doing so, you can more clearly see the total amount of the related asset account, which would otherwise have been obscured by the offsetting amount of the reserve. The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company’s auditors. The amount of this reserve is typically based on the company’s historical loss experience for each reserve.
1. Discount on Bonds Payable Liability Contra
A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset. To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together. As a reminder, assets and expenses are debit accounts whereas liabilities and revenues are credit accounts.
This prevents inflated revenue numbers and gives a clear picture of your net earnings. When a good is sold on credit, the amount receivable from customers is shown under the debtor’s balance sheet balance. It is a standard business practice to prepare an estimate for the amount likely to go bad. The provision for doubtful debts is a contra asset account related to debtors. With increasing globalization and companies operating in many countries, the books of accounts must be compatible with a global platform. They are also the result of globally accepted accounting principles for accurately reporting financial numbers.
Examples of Contra Asset Accounts
This requirement also comes from the accounting standard for inventories. There is the existence of contra accounts in accounting which are accounts that have the purpose of decreasing the value of another specific account if the two accounts are netted or summed together. We will define what contra accounts are, the types of contra accounts and provide examples to illustrate.
This is done to entice customers to keep products instead of returning them. The contra account offsets the parent account to reveal the remaining net amount of non-current assets. Long-Term Assets are parent accounts that contain the original acquisition cost of fixed assets.
The contra asset still resides on the asset side of the equation, just with a credit balance. You don’t have to, yet even a small business will benefit by using the contra asset account for accounts receivable. This eliminates the need to write off large accounts receivable balances at year end since they’ve already been accounted for. A contra account is an account with a balance opposite the normal accounts in its category.
To convert your invoice management efforts to an electronic format that can easily share data with other financial systems, businesses can leverage Invoiced’s E-invoice Network. The hottest retail item of today can be relegated to nostalgia channels on YouTube tomorrow. 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 the practice of bookkeeping, contra assets play a fundamental role in presenting a clear picture of a company’s financial health. They are used to adjust the value of related asset accounts and reflect transactions that affect a company’s financial statements. The calculated bad debts expense affects the income statement by recognizing an expense related to receivables that are unlikely to be collected. Concurrently, an allowance for doubtful accounts is established or adjusted, which is a contra-asset account that offsets the accounts receivable balance on the balance sheet. A contra asset account normally holds a credit balance as it is meant to reduce the debit balance of its corresponding asset. As the physical assets are utilized or become less valuable due to wear, tear, or obsolescence, contra asset accounts reflect this change and aid in representing the asset’s net value.
- Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing.
- When a customer takes advantage of early payment discounts, you also adjust revenue to reflect the actual amount received.
- A contra-equity account reduces the total value of your company’s equity.
- For example, a contra accumulated depreciation account can offset a fixed asset.
Financial statements rely heavily on the accurate reporting and use of contra assets. These considerations are vital for maintaining the integrity of financial reporting. By the end of the first-year machinery, the balance will be $100,000, and accumulated depreciation will show $20,000. By the end of 2nd-year, the machinery balance will still be $100,000, and accumulated depreciation will show $40,000.
- Whenever an organization buys an asset and depreciates it over the asset’s useful economic life, the reduction in value accumulates over the year, which is called accumulated depreciation.
- However, there are some prevalent contra-asset accounts that may exist for all companies.
- When a good is sold on credit, the amount receivable from customers is shown under the debtor’s balance sheet balance.
- For example, when your company borrows money, you would identify that debt in a Notes Payable account.
- Based on this equation, each account in the general ledger has a debit or a credit normal balance, which is used to identify whether an account should be debited or credited to increase its balance.
However, there are some prevalent contra-asset accounts that may exist for all companies. A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance. Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance.
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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. A debit to one account can be balanced by more than one credit to other accounts, and vice versa. For all transactions, the total debits must be equal to the total credits and therefore balance. Any company that owns intangible assets such as software, patents, etc., will maintain an accumulated amortization account.
It appears on the balance sheet and negates the gross amount of fixed assets such as buildings, machinery, office equipment, furniture, and vehicles. An important fact to note is that while the asset’s book value decreases, the accumulated depreciation increases, presenting the realizable value of the assets. A contra-asset account has a credit balance, which lowers the total asset value. A contra-revenue account has a debit balance, reducing total revenue, and a contra-liability account also has a debit balance.
By doing so, they can bring their asset accounts to a more accurate position. The most prominent of these include allowing companies to present a more accurate picture of their assets. For example, after six years, the asset’s book value on the balance sheet will be $40,000. Allowance for receivables is an account that companies maintain to record possible bad debts.