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. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. 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 less common example of a contra asset account is Discount on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable.
Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not Law Firm Accounting and Bookkeeping 101 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.
Contra Account
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. 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. This type of contra asset accounts is used for recording the depreciation within the timeframe of a fixed asset. Contra asset accounts are, as the name implies, accounts that are contrary to popular belief. Contra asset accounts have a credit balance as compared to a debit balance that most other types of accounts have.
- 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.
- That is to completely or partially offset the balance of their related asset accounts.
- The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
- If you offer credit terms to your customers, you probably know that not all of them will pay.
- 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.
Contra asset accounts are useful tools in double-entry accounting. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. 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.
Contra Account Examples
The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. By stating this information separately in a contra asset account, a user of financial information can see the extent to which a paired asset should be reduced. 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. The natural balance of a contra asset account, in this case, is exactly the opposite of the balance of the related account. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. A customer returned $100 worth of items, claiming them to be defective.
Including contra asset accounts on your balance sheets can be hugely beneficial for your business. Contra asset accounts are asset accounts where the balance is a credit balance. They are called “contra” asset accounts because these accounts are contrary to normal accounts. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. 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.
Examples of Contra Accounts
There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance.
- Contra liabilities reduce liability accounts and carry a debit balance.
- Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.
- Contra liability accounts are mainly used by corporations that issue bonds frequently.
- 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.
- This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000.
Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. However, that $1.4 billion is used to reduce the balance of https://personal-accounting.org/how-to-get-accounting-help-for-startup/ 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. These contras reduce the equity account and carry a debit balance.