Contra asset definition

In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups. Home Depot also devotes footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature.

There are three contra asset accounts that commonly appear in an organization’s chart of accounts. It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. 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).

There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory. Contra asset accounts provide business owners with the true value of certain asset accounts. 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 asset accounts are reported with the related account on the same financial statement.

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The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. Contra accounts allow you to show the amounts that offset a paired related account.

• The second entry will be accumulated depreciation, which will be in credit.
• When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000.
• The amount is reported on the balance sheet in the asset section immediately below accounts receivable.

Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account. 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. Sometimes, the current value of a note receivable will fall compared to its face value. This process will give rise to a contra asset account which is the discount on notes receivables.

Equity Contra Account

For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life. 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. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.

However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory.

Why Use a Contra Account?

Hopefully, you have a pretty clear idea of contra asset meaning—no need to ask to define contra asset accounts anymore. Including contra asset accounts on your balance sheets can be hugely beneficial for your business. In an accounting system, ledger accounts are designed to contain only similar transactions and/or 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. 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.

What is a contra asset account?

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. The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. 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. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance.

• The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.
• As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records.
• A contra asset (CA) account is an account in the balance sheet that offsets the balance of a regular asset account.

A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. In other words, contra revenue is a deduction from gross revenue, which results in net revenue. Any company that owns intangible assets such as software, patent, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. These accounts might also appear on the balance sheets of the company.

Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. Allowance for receivables is an account that companies maintain to record possible bad forecast your business’s profits and losses with a rolling budget debts. However, this account does not represent actual irrecoverable debts. 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.

The most prominent of these include allowing companies to present a more accurate picture of their assets. After each accounting period, the company records a depreciation expense of the asset. A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance. Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold.

Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired.

The contra asset account, accumulated depreciation, is always a credit balance. 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. 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. A bit more work will be required on the accountant’s or account analyst’s behalf if books are done manually without any software.