Contra Account Definition

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. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. For both contra asset accounts, the entry is a debit to an expense and the credit is to the contra asset account. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account.

A treasury stock is an example of a contra equity account that reduces the amount of total equity. Contra accounts are shown in the financial statements below the paired accounts, although sometimes the balances of the two accounts are merged to a net amount for presentation purposes. Consider what would happen if you have sales on credit that you reasonably expect will not be paid. In the example of Homes Inc. the percentage of customers defaulting on the account, and the amount defaulted, is estimable and probable. Past experience with uncollected bad debt has been, on average, 10% of credit sales. The sale to the Johnson family will create a bad debt expense estimate of 10% of the amount receivable. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings.

Why are Contra Accounts Important?

When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account. If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it. Balance sheet, users of financial statements can learn more about the assets of a company. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life.

• Because of the oppositional nature of these asset accounts, the contra account acts as a ‘contrary’ element to the debit balances of regular asset accounts.
• Companies must bring the balance of the discount on bonds payable account to zero over the life of the bond, which is accomplished through amortization.
• The contra revenue account is a reduction from gross revenue, which results in net revenue.
• Purchases of oil and gas wells, timber, and fossil and mineral deposits are recorded on a company’s balance sheet as natural resources.
• Each individual’s unique needs should be considered when deciding on chosen products.
• Consider what would happen if you have sales on credit that you reasonably expect will not be paid.
• 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.

When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Normal asset accounts have a debit balance, while contra contra account accounting asset accounts are in a credit balance. Offsetting the asset account with its respective contra asset account shows the net balance of that asset.

Reasons to include contra asset accounts on a balance sheet

A company might decide to purchase its stock when the board of directors feel the stock is undervalued or when it wishes to pay its shareholders dividends. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit.

Contra LiabilityA contra liability is a liability account that carries a debit balance as opposed to a credit balance. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts https://online-accounting.net/ receivable (A/R) balance to decline. Again, accumulated depreciation reduced fixed and capital asset balances. Apple breaks out its amount of property, plant, and equipment (PP&E) and then lists its accumulated deprecation that reduces the PP&E figure.

Accumulated Depreciation

This can be seen as a refund or the loss of revenue for the returned goods. Businesses use sales returns accounts to track product issues and customer trends.

• A company might decide to purchase its stock when the board of directors feel the stock is undervalued or when it wishes to pay its shareholders dividends.
• Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
• On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead.
• There can be hidden value in stocks that have a lot of fully depreciated buildings.
• For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately.
• Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares.

By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time. 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. It can be used for any type of account such as asset, liability, capital, revenue. Now let’s focus our attention on the two most common contra assets – accumulated depreciation and allowance for doubtful accounts. Accumulated DepreciationThe accumulated depreciation of an asset is the amount of cumulative depreciation charged on the asset from its purchase date until the reporting date. It is a contra-account, the difference between the asset’s purchase price and its carrying value on the balance sheet. The “Accumulated Depreciation” line item is the contra asset account reflected on the balance sheet, but often they are combined as “PP&E, net”.

Is a Contra Account a Debit or Credit?

Therefore, the depreciation of the equipment increases by approximately $50,000 for each year of use. This method uses the initial purchase value and subtracts the accumulated depreciation value for the time period to result in the total value of the equipment after its use. Suppose a company has recorded $100,000 in accounts receivable (A/R) and $10,000 in the allowance for doubtful accounts (i.e. 10% of A/R is estimated as uncollectible). 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).

Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. 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. Balance Sheet AccountsA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company. Now let us say that Power Manufacturers, Inc. reports its total credit sales for the quarter at $100,000, and it additionally estimates that 5% of all the credit sales made in the past quarter will default on payment. On the balance sheet, the allowance for doubtful accounts can reduce the totals in the business’s accounts receivable.

What Is the Benefit of Using a Contra Account?

FREE INVESTMENT BANKING COURSELearn the foundation of Investment banking, financial modeling, valuations and more. Treasury Stock AccountTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. Discount On Bonds PayableDiscount on bonds payable is the markdown value of a bond’s coupon rate or selling price compared to its market interest rate or fair value. $100,000 – $5,000 (the 5% allowance for doubtful accounts) to equal a net receivable amount of $95,000. Despite being classified as a liability, it functions more like an asset because benefits are provided to the company.