Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming. By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. Discount on notes receivable refers to a contra asset account that occurs when the current value of a note receivable amounts to less than the face value of the note. The resulting credit balances in these types of accounts may typically be amortized as interest revenue over the course of the note’s viable lifetime. In this article, you will learn what a contra asset account is, the types of contra asset accounts a business may have as well as an example of how common types of contra asset account balances are calculated.
If the related account has a debit as the natural balance, then the contra account will record a credit. Contra liabilities are not seen on a balance sheet as often as contra assets. Discount on bonds payable is a result of a bond issued for less than the face value of the bond. Companies must bring the balance of the discount on bonds payable account to zero over the life of the bond, cash basis which is accomplished through amortization. The amount recorded in the discount on bonds payable account is amortized to interest expense over the life of the bond. Amortization of the discount on bonds payable account decreases its balance and increases the balance in the interest expense account. The contra asset account, accumulated depreciation, is always a credit balance.
Overview: What Is A Contra Asset Account?
This basic portrait provides decision makers with fairly presented information about the accounts receivables held by the reporting company. Offset to an account that reduces the total balance to a net amount; in this chapter, the allowance for doubtful accounts always reduces accounts receivable to the amount expected to be collected. A contra asset account reflecting the estimated amount of accounts receivable that will eventually fail to be collected and, thus, written off as uncollectible. Personal accounts are liabilities and owners’ equity and represent people and entities that have invested in the business. This method is used in the United Kingdom, where it is simply known as the Traditional approach. The Equity section of the balance sheet typically shows the value of any outstanding shares that have been issued by the company as well as its earnings. All Income and expense accounts are summarized in the Equity Section in one line on the balance sheet called Retained Earnings.
Accumulated depletion is similar to accumulated depreciation but takes into account the total amount depleted from natural resources. Purchases of oil and gas wells, timber, and fossil and mineral deposits are recorded on a company’s balance sheet as natural resources. These are physically extracted and only replaced by a natural process.
On the other hand, increases in revenue, liability or equity accounts are credits or right side entries, and decreases are left side Contra Asset Account Examples entries or debits. A machine purchased for $15,000 will show up on the balance sheet as Property, Plant and Equipment for $15,000.
The total decrease in the value of an asset on the balance sheet over time is accumulated depreciation. The values of all assets of any type are put together on a balance sheet rather than each individual asset being recorded. Allowance for Doubtful Accounts, Accumulated Depreciation, and Valuation Allowance for Marketable Securities are contra asset accounts; while Discounts on Bonds Payable is an example of a contra liability account. Treasury stock and drawing accounts are examples of contra equity accounts. Net book value the difference between cost and accumulated depreciation so from cost we deduct accumulated depreciation and get $6,400 and this a month goes to the balance sheet. And this is how the T account looks like on the top we have a name of the account and debit on the left side and credit on the right side. The amount in the accumulated depreciation account is deducted from the assets of a company, such as buildings, vehicles and equipment.
The Difference Between The Balance Of Assets & Its Related Accumulated Depreciation
Liabilities, conversely, would include items that are obligations of the company (i.e. loans, accounts payable, mortgages, debts). Contra accounts are helpful in determining the historical cost of a company, these accounts help financial managers and accountants keep a clean and easy-to -track financial records. Maintaining a good record of historical cost is important for tax preparation.
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 accounts are those paired with a related account and used to track and offset the value of the account they’re associated with. For example, if your account normally has a debit balance, the contra account associated with it would have a normal credit balance. 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 accurate reporting of financial numbers.
Likewise, separating the allowance for bad debt from accounts receivable lets you calculate the profitability of your sales team. Other examples of contra accounts deal with variables where the exact value is unknown.
As we have seen in the above discussion, how reporting contra assets account helps in a better understanding of financial statements of any organization. So, an organization looking for a robust accounting process must move to this type of reporting for better understanding. 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 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. Some companies include both accounts on the balance sheet to explain the origin of the reported balance. Others show only the single net figure with additional information provided in the notes to the financial statements.
2 Accounting For Uncollectible Accounts
This can help anyone viewing the financial information to find the historical cost of the asset. The accumulated what are retained earnings depreciation amount shows how much depreciation expense has been charged against an asset.
- Before you issue a balance sheet, fix any errors and reclassified any asset accounts with a credit balance as a liability.
- With each debited to your expense account related to useless inventory, you’ll create a corresponding credit in the reserve for obsolete inventory asset account.
- Reserve for obsolete inventory is a contra asset account that is used to reduce the net value of a company’s balance sheet.
- The bad debt, or allowance for doubtful accounts has a credit balance to offset the value of accounts receivable.
- The only real reason you would want to have asset accounts with a credit balance is if they were intentionally set up as a contra asset account.
- So, essentially, all these situations are mistakes that people could make.
“Daybooks” or journals are used to list every single transaction that took place during the day, and the list is totalled at the end of the day. The information recorded in these daybooks is then transferred to the general ledgers. Not every single transaction needs to be entered into a T-account; usually only the sum of the book transactions for the day is entered in the general ledger. From the bank’s point of view, when a debit card is used to pay a merchant, the payment causes a decrease in the amount of money the bank owes to the cardholder. From the bank’s point of view, your debit card account is the bank’s liability.
An Allowance for Uncollectible Accounts is reported on a line directly below the accounts receivable in a company’s financial statements. For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances. A separate account used in such a situation is sometimes called a adjunct account. For the purpose of presentation on primary financial statements, we are often concerned only with the net figure of two similar classes/balances which we determine by subtracting one account from the another.
Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. Recording asset accounts and depreciation separately, for instance, tells anyone reviewing your balance sheet how much the asset cost, how much it has depreciated http://mooc.eiu.edu.bz/why-accrual-accounting-is-best-for-managing-cash/ and how much of a useful life remains. They wouldn’t know any of that if you just subtracted depreciation and recorded only the asset’s net value. You don’t have to, yet even a small business will benefit by using the contra asset account for accounts receivable.
Accumulated depletion accounts for the reduction of value in a natural resource. For example, as a company extracts oil from an oil well over a period of time, the value of the oil well declines. The amount of the Contra Asset Account Examples decline is recorded in the accumulated depletion account. If your factory equipment represents a $1.7 million asset but it’s depreciated by $700,000, you’d record the depreciation in a contra asset account.
The amount of gross revenue minus the amount recorded in the contra revenue accounts equal a company’s net revenue. A transaction is made under the sales return account when a customer returns a product to the company for a refund.
Contra Asset Definition
It’s ok to have a credit balance in an accumulated depreciation asset account, but the net value of an asset should never go below zero. Contra asset accounts aren’t the only way that asset accounts can carry a credit balance. Another example when we use contrary accounts it is accounts receivable and provision foreign collectible accounts. We have accounts receivable gross and this account has debit balance and we have allowance from collectible accounts and this account has credit balance. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts. Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue.
What is an example of a contra asset?
The most common contra asset account is Accumulated Depreciation. Accumulated Depreciation is associated with property, plant and equipment (plant assets). Accumulated Depreciation will be credited when Depreciation Expense is recorded. A less common example of a contra asset account is Discount on Notes Receivable.
In other words, contra accounts are used to reduce normal accounts on the balance sheet. Contra assets may be stated in separate line items on the balance sheet. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet.
The definition of an asset according to IFRS is as follows, “An asset is a resource controlled by the entity as a result of past events from which future economic benefits are expected https://kelleysbookkeeping.com/ to flow to the entity”. In simplistic terms, this means that Assets are accounts viewed as having a future value to the company (i.e. cash, accounts receivable, equipment, computers).
Hence, contra accounts are not just meant for the purpose of reducing the value of the associated accounts, they are useful in tax preparation. Here’s a short list of some example contra asset accounts and their corresponding asset accounts. So this is a covering of T account essence and relation of it to the accounting equation. A contra equity account reduces the total number of outstanding shares listed on a company’s balance sheet.
This eliminates the need to write off large accounts receivable balances at year end since they’ve already been accounted for. 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. Nowadays, with the development of a computerized accounting system, it is easy and quick to prepare the contra asset accounts as the system does all the calculations, and hardly anything is pushed bookkeeping manually. However, an accountant or person in charge must ensure that any change in the value of the assets due to revaluation or impairment must be taken into consideration. Also, with IFRS asking to report it in a particular way, the accountants must be updated with recent changes as to how the contra assets account should appear in the books of accounts. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.
The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible. The balance sheet shows the amount in the asset section underneath the accounts receivable. The net value of both these figures is usually reported on a third line.
Comparing the two gives you the book value of $1 million on the equipment. 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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet. A contra account is an account with a balance opposite the normal accounts in its category. Contra accounts are usually linked to specific accounts on thebalance sheetand are reported as subtractions from these accounts.