contra asset account definition

These billings may usually be documented on invoices, which are then summarized in an aging report for all the business’s accounts receivable. Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life to account for declines in value over time.

What is a contra asset and how does it work?

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.

Generally speaking, goodwill refers to favorable relations with customers. Upon receipt of the invoice, the customer paid in cash immediately. Sales Discounts – Amount of discount given to customers who contra asset account definition are usually able to pay earlier than the due date of an invoice. Sales Returns – Amount that is reduced from the gross revenue for goods that have been previously sold but returned to the seller.

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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. The two common contra the normal balance in a contra asset account is liability accounts, discount on bonds payable and discount on notes payable, carry normal debit balances. The discount on bonds payable represents the difference between the amount of cash a company receives when issuing a bond and the value of the bond at maturity. Notes payable represents a liability created when a company signs a written agreement to borrow a specific amount of money. A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance.

contra asset account definition

Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.

What is the importance of Contra Asset Accounts?

A contra liability account is the lesser known type of a contra account. Contra asset accounts are necessary for companies for various reasons. The most prominent of these include allowing companies to present a more accurate picture of their assets. Allowance for receivables is an account that companies maintain to record possible bad debts.

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On the other hand, increases in revenue, liability or equity accounts are credits or right side entries, and decreases are left side entries or debits. A contra equity account reduces the total number of outstanding shares listed on a company’s balance sheet. When a company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account. A company may decide to buy back its shares when management feels the stock is undervalued or because it desires to pay stock dividends to its shareholders.

Contra Accounts: Definition, Meaning, Examples, Types, Importance

The contra equity account reduces the total amount of shareholders’ equity. Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. An allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported to reflect only the amounts expected to be paid. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. This type of account could be called the allowance for doubtful accounts or bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.

The amount is reported on the balance sheet in the asset section immediately below accounts https://online-accounting.net/ receivable. The net of these two figures is typically reported on a third line.

Contra-account definition

Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Companies may elect to operate and provide their annual financial statements on either a calendar or fiscal year basis.

  • The contra revenue accounts commonly used in small-business accounting include sales returns, sales allowance and sale discounts.
  • 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.
  • The basic principle is that the account receiving benefit is debited, while the account giving benefit is credited.
  • Likewise, in the liability account below, the X in the credit column denotes the increasing effect on the liability account balance , because a credit to a liability account is an increase.
  • When a company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account.
  • Personal accounts are liabilities and owners’ equity and represent people and entities that have invested in the business.

This requirement also comes from the accounting standard for inventories. The accounting entries for accumulated depreciation are as follows. This transaction records when a customer returns the paid goods, and a refund must be given.

Financial Management: Overview and Role and Responsibilities

Accounts receivable result in a cash inflow to an organization when they repay their dues. They are the current assets of a company expected to be realized within 12 months. Contra Accounts help show the net value of an account in the financial statements. The accounting entries for a discount on notes receivables are as follows. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account.

contra asset account definition

Allowances for bad debts under receivables accounts and bad debt accounts are contra accounts to a revenue account. The outstanding balance of a contra asset account represents a credit figure. These accounts are maintained individually and are adjusted from the corresponding asset’s balance to show the net amount of the assets in financial statements. The bad debt, or allowance for doubtful accounts has a credit balance to offset the value of accounts receivable. You can use this contra asset account to represent this uncertainty. A contra account is used for account classification and is also reported in a company’s financial statement alongside its corresponding or related account.

Key examples of contra accounts include accumulated deprecation and allowance for doubtful accounts. The totals show the net effect on the accounting equation and the double-entry principle, where the transactions are balanced. The Profit and Loss Statement is an expansion of the Retained Earnings Account.

contra asset account definition