Contra Asset Examples, How a Contra Asset Account Works

28 Aug Contra Asset Examples, How a Contra Asset Account Works

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. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet. At some point, a company will have to concede that they have inventory that can’t be sold. Such would be the case with a pallet of rotten tomatoes in a grocer’s warehouse, for example, or a stock of outdated computer components.

A company estimates how much of its inventory will “go bad” based on its past experience, its assessment of current industry conditions, and its knowledge of customer tastes. This credit card is not just good – it’s so exceptional that our experts use it personally. It features a lengthy 0% intro APR period, a cash back rate of up to 5%, and all somehow for no annual fee! Click here to read our full review for free and apply in just 2 minutes.

Contra asset accounts journal entries

This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. 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.

A debit will be made to the bad debt expense for $4,000 to balance the journal entry. 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. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000.

When this happens, the company “writes off” those items, meaning it takes them off the books, and the company absorbs the costs. For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date. 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. The other item the GAAP rules guard against is the potential for a company to overstate its value by overstating the value of inventory.

The most common contra equity account is called “treasury stock.” This special account decreases the number of shares outstanding in the market because the company repurchases some of the shares from its buyers. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. 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.

Why are contra asset accounts important for businesses?

Contra liability accounts are less commonly used than contra asset accounts. 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. Contra https://www.bookkeeping-reviews.com/what-are-accounting-advisory-services/ liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount.

1. At some point, a company will have to concede that they have inventory that can’t be sold.
2. Inventory reserve accounts for the predicted amount of inventory that will not be able to be sold that year.
3. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.
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5. A contra inventory account is a general ledger account with a credit balance.

The difference between an asset’s account balance and the contra account balance is known as the book value. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting journal entry software currently available. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability.

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This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders. This can be seen most prominently in products that require exceptional time or expense in secondary stages of production. Items such as pharmaceuticals, machinery, and technology are three products that require large amounts of expense after their initial designing. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent.

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 equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.

Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount.

Contra inventory account definition

In this scenario, a write-down is recorded to the reserve for obsolete inventory. 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. The account offsets the balance in the respective asset account that it is paired with on the balance sheet. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.