There is the existence of contra accounts in accounting which are accounts that have the purpose of decreasing the value of another specific account if the two accounts are netted or summed together. And let’s not forget the all-important Allowance for Doubtful Accounts, acting as a financial crystal ball that estimates the portion of accounts receivable that might just turn into fairy dust. Businesses benefit by forecasting more realistic revenue figures, which helps in strategic planning and maintaining investor confidence. A contra account is a type of account that is used to offset another account.
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- He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.
- The mechanics of contra accounts revolve around the concept of the “normal balance” of an account.
- In a report, layering on that additional context can be easy, but in a general ledger, you have few options for conveying nuance and subtlety.
- Instead of reducing accounts receivable directly, companies record expected bad debts in a contra asset account.
- These contra accounts effectively reduce the gross amount of asset accounts to their net book value, providing stakeholders with a realistic depiction of asset values on the balance sheet.
- The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected.
Key Aspects of Contra Accounts:
A contra liability account is not classified as a liability, since it does not represent a future obligation. While a contra asset account offsets the balance of an asset, a contra revenue account offsets revenue. A business might elect to separately state contra asset accounts on its balance sheet, so that the users of its financial statements can obtain additional information about the contents of these accounts. If you need to reduce an asset, use a contra asset account like accumulated depreciation. If you’re adjusting revenue, use a contra revenue account such as sales returns and allowances. A Contra Account is an account used in accounting to reduce the value of a related account.
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Companies can maintain financial correctness by adjusting revenue and asset values by sales returns and allowances. Contra accounts are a type of account used in financial analysis that offsets the balance of another account. They are used to provide transparency in accounting by showing adjustments or reductions made to certain accounts. They’re balance sheet accounts, but their activity (like depreciation expense) may flow through to the income statement as an expense.
#4 – Accumulated Depreciation
Instead of changing the main asset account, reductions are tracked separately. Common contra asset accounts include accumulated depreciation, allowance for doubtful accounts, and accumulated amortization. Asset accounts have a normal debit balance, meaning they increase with a debit entry. A contra asset account, such as Accumulated Depreciation, must therefore have a normal credit balance, increasing with a credit entry. This inherent opposition allows the contra account to reduce the primary account’s overall debit balance.
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However, it’s important to keep in mind that you can create any contra account you want to more clearly describe your business — this is not an exhaustive or definitive list. Businesses experience a world of benefits from maintaining accurate contra account records. By reflecting the true health and value of assets, liabilities, and equity, they support a realistic assessment of financial standing. It tracks how much of an asset’s value has been used up while leaving the original purchase price intact. For instance, ABC Company buys manufacturing equipment for $60,000 with a 5-year useful life and no salvage value.
#1 – Assets
The purpose of the Allowance for Doubtful Accounts is to track the reduction in the value of the asset while preserving the historical bookkeeping value of the asset. They make your numbers more trustworthy, your reports more clear, and keep your books audit ready. Even when sales look strong, that number doesn’t necessarily tell the full story.
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Contra accounts are not limited to assets and revenue; they contra asset account also modify the Equity and Liability sections of the balance sheet. These applications ensure the reported shareholder interest and debt obligations are accurately stated. The original cost of the asset remains unchanged on the company’s books, and Accumulated Depreciation is increased via a credit entry each period.
How Contra Assets Appear on Financial Statements
This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). We will define what contra accounts are, the types of contra accounts and provide examples to illustrate.