What Is a Contra Account? The Motley Fool

The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Startup Bookkeeping Services Tax Preparation, Bookkeeping, and CFO Servicess 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. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement.

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. The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account.

Financial Management: Overview and Role and Responsibilities

These accounts might also appear on the balance sheets of the company. ADAs are used to create allowances for clients that bought the company’s goods or services but somehow failed to pay the owed https://accounting-services.net/a-2023-guide-to-tax-returns-for-seed-stage/ amount. 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).

• 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.
• Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.
• That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable.
• It represents all the depreciation related to an asset or the company’s overall assets.
• 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 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. Contra liability accounts are special accounts in the liabilities section of the balance sheet. They aim to reduce the balance of some related liability accounts. This would let users of the financial statements calculate the book value of the liability.

Contra Account Definition in Accounting

By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. Contra asset accounts are a type of contra account that net off against asset accounts. These include accumulated depreciation, accumulated amortization, allowance for receivables, obsolete inventory, and discount on notes receivables. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts.

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 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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Setting up contra asset accounts is easy with accounting software.

Contra asset definition

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. 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.

• In an accounting system, ledger accounts are designed to contain only similar transactions and/or balances.
• A contra account is an account that companies use to reduce the value of a related account.
• Suppose a clothing business has sold $50,000 of inventory on credit.
• 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.
• For example, if the balance of accumulated depreciation increases from $20,000 to $50,000, this means that the depreciation expense amounts to $30,000, which will be listed in the income statement.

Contra asset accounts have a credit balance as compared to a debit balance that most other types of accounts have. Before we start talking about the finer details, it’s important to know what is a contra asset account. In an accounting system, ledger accounts are designed to contain only similar transactions and/or balances. A separate account is needed whenever the nature of transactions changes. It is because clubbing together dissimilar transactions impedes any analysis.

Why are contra asset accounts important for businesses?

The money left over after a company supports operations can be a snapshot of its financial health. Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature. Let’s go over how they work and what the main types are, and then finish with an example.

The definition can be expanded to include contra accounts in general. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. Allowance for receivables is an account that companies maintain to record possible bad debts.

How to Record a Contra Account

There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance.

By doing so, they can bring their asset accounts to a more accurate position. Instead, the existence of contra-asset accounts for companies will differ based on a company’s requirements. For example, if an account has a debit balance, a contra account will have a credit balance.