The amount is reported on the balance sheet in the asset section immediately below accounts receivable. The net of these two figures is typically reported on a third line. The second entry will be accumulated depreciation, which will be in credit. 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 – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline.
- This will repeat until the machinery has been totally depreciated, sold, or retired.
- The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
- Contra liability accounts are not as popular as contra asset accounts.
- The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level.
Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. https://www.wave-accounting.net/fund-accounting-101-basics-unique-approach-for/ 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.
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The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated.
Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.
Contra Revenue Account
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. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. The contra asset account, accumulated depreciation, is always a credit balance. This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. To oppose the revenue made by a company, contra revenue accounts must have a debit balance.
For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. Contra assets may be stated in separate line items on the balance sheet. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet. In either case, the net Nonprofit Accounting Explanation amount of the pair of accounts is referred to as the book value of the asset account in question. When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. A contra asset is a negative asset account that offsets the asset account with which it is paired.
What Is the Benefit of Using a Contra Account?
For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company.
This will repeat until the machinery has been totally depreciated, sold, or retired. Another question that we get is what is the relationship between a contra asset balance and the book value. Investopedia notes that the difference between the asset’s contra account balance and its account balance is called the book value. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.