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Define Contra Asset Account

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. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts.

What is the importance of Contra Asset Accounts?

Define Contra Asset Account

The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. Contra accounts act like regular accounts on the balance sheet but have a unique purpose.

Bookkeeping with Contra Asset Accounts

When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find. Companies bury them in the footnotes and often don’t break out the actual calculation. Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts.

Contra Liability Account: What it is, How it Works, Example

Accounts Receivable is an asset account that represents the amount of money due to a business for goods or services that have been delivered or used but not yet paid for by customers. Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential http://makedonskosonce.com/60623/ in various calculations. For example, after six years, the asset’s book value on the balance sheet will be $40,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost. This account offsets the balance in the respective asset account that they pair with on the balance sheet.

How are Contra Accounts Used and Reported?

This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid). Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. 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.

  • Accounts Receivable and Allowance for Doubtful AccountsA classic example of a contra asset account is the Allowance for Doubtful Accounts.
  • If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it.
  • Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.
  • The Reserve for Obsolete Inventory contra asset account is used to estimate and reduce the value of inventory that is no longer sellable or has diminished in value.
  • Sales and Sales Returns and AllowancesBusinesses also deal with sales returns and allowances, which are recorded in a contra revenue account.
  • This process will give rise to a contra asset account which is the discount on notes receivables.

Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset http://mobbit.info/item/2008/4/30/divany-byvaut-raznye-25-foto counterpart is listed underneath, with the asset’s net value or book value. Note that in accounting, the term “book value” is also used interchangeably with net value.

Define Contra Asset Account

The most prominent of these include allowing companies to present a more accurate picture of their assets. 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.

This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time. The difference http://www.psychology-online.net/articles/doc-611.html between an asset’s account balance and the contra account balance is known as the book value. 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.

  • This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67.
  • 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.
  • Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances.
  • The contra liability account is less common than the contra asset account.
  • This creates a direct link between the reduction of fixed asset value on the balance sheet and the recognition of expenses on the income statement.

A liability that is recorded as a debit balance is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. This depreciation is saved in a contra asset account called accumulated depreciation.