For example, we need separate accounts to hold the actual cost of property, plant and equipment (PPE) and related accumulated depreciation. If we record depreciation expense in the cost accounts directly, we will lose key information about the original cost of the assets and accumulated depreciation. To avoid this loss of important data, we record actual cost and depreciation in separate ledger accounts. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds.
Usually, companies add to the accumulated depreciation account after every accounting period. Every Law Firm Bookkeeping 101 on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets. Revenue is an income statement account, but it flows through to the equity section of retained earnings as well. Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement. The contra asset account, accumulated depreciation, is always a credit balance.
Definition and Examples of Contra Assets
Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. 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. 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. Sometimes, the current value of a note receivable will fall compared to its face value.
The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. 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. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability.
Contra Account Examples
A https://www.wave-accounting.net/what-is-the-average-cost-of-bookkeeping-services/ example is an accumulated depreciation account that will help the company track and offset fixed assets. Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable.
When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. 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. Contra liability, equity, and revenue accounts have natural debit balances.
Why are contra asset accounts important for businesses?
The most prominent of these include allowing companies to present a more accurate picture of their assets. On the other hand, accumulated depreciation is a contra-asset account. A company, ABC Co., purchased a depreciable asset worth $100,000.
- To oppose the revenue made by a company, contra revenue accounts must have a debit balance.
- While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company.
- 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.
- Offsetting the asset account with its respective contra asset account shows the net balance of that asset.
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. The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company’s auditors.
Overview: What is a contra asset account?
The allowance for these doubtful accounts can ultimately result in the total number of receivables. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. The $10,000 of depreciation will reduce the book value of the car.
Contra accounts are a significant part of a company’s financial statements. These accounts can significantly reduce balances on the balance sheet. The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings.