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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. The net of the asset and its related contra asset account is referred to as the asset’s Best Accounting Software For Nonprofits 2023 book value or carrying value. Contra asset accounts help companies record any reductions to their non-current and current assets. By doing so, they can bring their asset accounts to a more accurate position. Contra asset accounts are necessary for companies for various reasons.

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. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. This account appears next to the current asset Accounts Receivable. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers. 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.

How Contra Asset Accounts Work

Therefore, contra-asset accounts differ from other accounts that have a credit balance. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance. Both of these accounts offset each other to represent a net balance on a company’s balance sheet. Inventory obsolescence is an expense account, while the Accounting & Financial Planning Services for Attorneys and Law Firms allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet. In accounting, assets are things of value that your business owns. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.

This account offsets the balance in the respective asset account that they pair with on the balance sheet. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to. Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. 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.

How are Contra Accounts Used and Reported?

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. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement.

Notes receivables are promissory notes that include a promise from a borrower to repay a lender. Companies that hold inventories for a long time may face accumulating obsolete inventory. The accounting entries for allowance for receivables are as follows. 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.

Definition of Contra Asset Account

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. 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. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.

The contra asset account Accumulated Depreciation is related to a constructed asset(s), and the contra asset account Accumulated Depletion is related to natural resources. Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances. This account helps companies present a more accurate accounts receivable balance on the financial statements. Accumulated depreciation is the most prevalent type of contra-asset account. It represents all the depreciation related to an asset or the company’s overall assets. Usually, companies add to the accumulated depreciation account after every accounting period.

Overview: What is a contra asset account?

The contra liability account would be used to offset the liability account on the balance sheet. The company estimates that it will not be able to collect 1,000 from its customers. The allowance for doubtful accounts is a contra asset account that is used to offset Accounts Receivable on the balance sheet. While tracking contra asset https://quickbooks-payroll.org/accounting-for-a-non-profit-organization/ accounts is cumbersome for bookkeepers and accounting clerks using manual accounting systems, if you’re using accounting software you’ll find that most of the heavy lifting is done for you. 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.

• Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.
• Whenever the balance of a contra asset account increases (credit to the contra asset account), the increased amount is written off as an expense and is reported in the company’s income statement.
• This contra-asset account reduces the accounts receivable balance on the balance sheet to its net realizable value.
• By recording reductions in a separate account, companies can get better insights into their actual 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.