The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level. When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. 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). The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
- The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
- 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.
- Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.
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This allows the reader to see both the current and historical book values for a particular asset or liability. A contra liability is an account in which activity is recorded as a debit balance is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts.
Is a Contra Balances Negative or Positive?
In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. A contra asset is a negative asset account that offsets the asset account with which it is paired.
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. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company.
Understanding a Contra Account
Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. A less common example of a contra asset account is Discount https://accounting-services.net/what-is-a-contra-asset-account/ on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable.
Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit. 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. 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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners.
Contra Account Examples
Taking into account the list of contra asset accounts, how would you calculate the net value of assets? If the example looks difficult, rest assured the solution is very simple. Because contra assets simply detract from the total value of the asset account, all one has to do is add up all the assets together first. Finally, take the total of depreciation and subtract it from total assets. If a ledger were to be observed in this situation, then one would see a balance of three asset debits (van, building, equipment) matched up against three contra asset credits (van, building, equipment). By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account.
