An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. A second example of a contra asset account is Accumulated Depreciation. Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable. They are used in case some customers won’t be able to pay the money they owe to the business.
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. Allowance for receivables is an account that companies maintain to record possible bad debts. However, this account does not represent actual irrecoverable debts. Accumulated amortization is an account similar to accumulated depreciation. This account only relates to a company’s intangible assets rather than tangible.
The accounting entries for allowance for receivables are as follows. The accounting entries for accumulated depreciation are as follows. The allowance for these doubtful accounts can ultimately result in the total number of receivables. ADAs are used to create allowances for clients that bought the company’s goods or services but somehow failed to pay the owed amount. This allows the financial analyst to evaluate the company inventory’s current market value.
This will repeat until the machinery has been totally depreciated, sold, or retired. Contra asset accounts are reported with the related account on the same financial statement. At the end of year 20, the car and the accumulated depreciation accounts will be written off from the balance sheet, as the car will be a fully depreciated asset. 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.
When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950.
They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance.
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.
Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. 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.
This improvement in the accounting details and transparency is good for any business in multiple ways. These accounts might also appear on the balance sheets of the company. 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. In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.
A contra account carries a balance that is opposite to the normal balance of its related main account. Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations.
To oppose the revenue made by a company, contra revenue accounts must have a debit balance. Revenue is an income statement account, but it flows through to the equity section of retained earnings as well. Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement. Then, the company establishes the allowance by crediting an allowance account often called ‘Allowance for Doubtful Accounts’. Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets.
Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts). The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000.
A contra account is a negative account that is netted from the balance of another account on the balance sheet. Contra asset accounts are hugely beneficial for nearly all types of companies. A contra asset account example is an accumulated depreciation account that will help the company track and offset fixed assets. 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. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s how long should i keep my tax records balance and the contra account asset balance is the book value. Contra asset accounts are useful tools in double-entry accounting.
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. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales.