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contra account definition and meaning

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. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. 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.

Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets. In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. The difference between the gross balance of a main account and its contra accounts reported as the net balance in a company’s financial statements corporation is also referred to as a book value, current value, carrying value, or net realizable value. If a company sells a bond at a discount, the difference between the cash received and the value of the bond it sold will be listed as “discount on bonds payable,” which is a contra liability account, the counterpart of bonds payable. Note that in accounting, the term “book value” is also used interchangeably with net value.

  • If you’re still using manual accounting systems, you’ll need to do a bit more work by recording your accumulated depreciation expense in your general ledger while also reporting it on your balance sheet as a contra asset account.
  • For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account.
  • Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock.
  • Accounting software can simplify the management of and reporting from your ledger.

In other words, the LIFO reserve is critical because it ultimately offers the most accurate and most complete picture of a company’s inventory, sales, revenue, and profits. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. 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).

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. Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account. Treasure stock is a good example as it carries a debit balance and decreases the overall stockholders’ equity. If the LIFO reserve account balance goes up or down, additional costs are then added on to the costs of the goods the company has sold throughout the year. This information is integral for investors because it enables them to see how inflation affects the value of the company’s inventory, or it allows them to determine the taxation benefits of using the LIFO or FIFO accounting methods. A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger.

A final word about contra asset accounts

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. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Both the LIFO and FIFO methods fall in line with the Generally Accepted Accounting Principles (GAAP) established by the Financial Accounting Standards Board (FASB) in the US. The goal is to make the presentation of inventory value as attractive as possible.

  • 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 contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
  • If the LIFO reserve account balance goes up or down, additional costs are then added on to the costs of the goods the company has sold throughout the year.
  • The credit balance in the contra inventory account will be combined with the debit balance in the inventory account when a balance sheet is prepared.

Contra revenue accounts typically offset revenue accounts in a firm’s income statement. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset.

Accounting Terms: U

If you’re still using manual accounting systems, you’ll need to do a bit more work by recording your accumulated depreciation expense in your general ledger while also reporting it on your balance sheet as a contra asset account. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.

Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance. ABC International’s controller decides to maintain a 3% inventory reserve, based on the company’s historical experience with inventory losses. This amounts to a $30,000 debit to the cost of goods sold, and a $30,000 credit to the inventory reserve contra account. The company later identifies $10,000 of obsolete inventory; it writes down the value of the inventory with a $10,000 debit to the inventory reserve contra account and a credit to the inventory account.

Contra Account

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. The most common contra type, contra assets, records the loss in value of any asset accounts listed in your general ledger. And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business. Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes. Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet.

What are Contra Accounts?

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. In order to create a balance between the two methods and to give a fuller picture of a company’s financial realities, the LIFO reserve account is necessary. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.

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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. When this happens, the company “writes off” those items, meaning it takes them off the books, and the company absorbs the costs. Inventory reserve is an estimation of future inventory spoilage based on the company’s past experiences. Once inventory that is unable to be sold is actually identified it is written down in official recognition of the loss. Wanting to spruce up its aging inventory, Show-Fleur purchased new, climate controlled-seats for its fleet, delivering increased comfort for passengers and a cleaner, more modern look for vehicle interiors.

Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Since a portion of a company’s inventory goes unsold each year, it makes sense that the company would not include the entire amount of its inventory as an asset on their balance sheet. The inventory reserve contra asset account subtracts value from the inventory asset entry on the balance sheet to create a more accurate representation of the portion of inventory that will actually be sold to create future value for the company.

The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing. If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $10 thousand in discounts during that same timeframe. In reality, the actual number of company discounts came closer to $5 thousand. 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.

In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported.

The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet. Using the allowance for doubtful accounts, the contra asset account will more accurately reflect your true accounts receivable balance and make sure sure that your financial statements reflect the most accurate information possible. In anticipation of this, the company will create an entry on the balance sheet called inventory reserve. Inventory reserve accounts for the predicted amount of inventory that will not be able to be sold that year.