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 Basic Accounting Tips for Churches and Nonprofits 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.
An entry will be recorded on the credit side if and when a debit entry is recorded in an account and vice-versa. For example, an asset was purchased by a company for $100,000 – that https://business-accounting.net/how-to-correct-and-avoid-transposition-errors/ is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. Therefore, the asset’s net value (or the book value) will be $70,000.
Contra Account Examples
The contra equity account would be used to offset the equity account on the balance sheet. This would give a more accurate picture of the company’s equity. 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.
- There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry.
- A customer returned $100 worth of items, claiming them to be defective.
- Contra asset accounts are necessary for companies for various reasons.
- The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts.
- An example of contra equity with buying back shares or stock would be a company that has issued shares to the public.
- An asset account which is expected to have a credit balance (which is contrary to the normal debit balance of an asset account).
Before we start talking about the finer details, it’s important to know what is a contra asset account. The same is true for other asset accounts like accounts receivable. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Accumulated depreciation is the most prevalent type of contra-asset account.
Discount on Notes Receivable
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. The Basic Accounting Equation Formula & Explanation Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets.
- This type of accounts involves the products or goods of a company that is now unusable or obsolete.
- For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
- Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.
- The definition can be expanded to include contra accounts in general.
- Investopedia notes that the difference between the asset’s contra account balance and its account balance is called the book value.
Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account.
Allowance for Receivables
A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear in the financial statements directly below their paired accounts. Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance.
For example, after six years, the asset’s book value on the balance sheet will be $40,000. This amount will include the asset’s original cost of $100,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account.