Contra Account Definition, Types, and Example
Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature. Let’s go over how they work and what the main types are, and then finish with an example. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. The sales allowance shows the discounts given to customers when returning the product. This is done to entice customers to keep products instead of returning them.
- With contra equity accounts, you reduce the number of outstanding shares you list on your company’s balance sheet.
- QB itself isn’t set up to handle something like this on its own, so manual entries is the only way I know of to take care of it.
- Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory.
Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. When an entry is made to the depreciation expense account, the offsetting credit is to the accumulated depreciation account, which is a contra asset account that offsets the fixed assets (asset) account. The balance in the depreciation expense account increases over the course of an entity’s fiscal year, and is then flushed out and set to zero as part of the year-end closing process. The account is then used again to store depreciation charges in the next fiscal year.
List of Contra Accounts
Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values. Home Depot also devotes footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. The estimated life of the machinery is 10 years and every year, 10% of the value is written off as deprecation (Straight-line method).
Contra accounts act like regular accounts on the balance sheet but have a unique purpose. The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount. This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.
They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value. Contra accounts serve an invaluable function in financial reporting that enhances transparency in accounting books. If a listed company purchases its own shares from the open market, it will have to debit the treasury stock account in order to record the transaction. 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. The amount in the accumulated depreciation account is deducted from the assets of a company, such as buildings, vehicles and equipment.
This would let users of the financial statements calculate the book value of the liability. In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance. The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
QB itself isn’t set up to handle something like this on its own, so manual entries is the only way I know of to take care of it. I strongly suggest having a trained Accountant do this (or something in a similar vein) if you need it done for your business. Overall, while maintaining contra accounts may require additional effort, the benefits they offer in terms of financial transparency and accountability make them an essential tool in accounting. Utilizing contra accounts in financial accounting has several significant advantages that enhance financial transparency and enable more effective financial management. By understanding the nature and function of contra accounts, businesses can accurately reflect their financial position, providing transparency to stakeholders such as investors, creditors, and internal management.
As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records. As such, for an asset or expense account that is naturally a debit account, the contra accounts will be in a credit position. For a liability or revenue account that are naturally credit accounts, the contra accounts will be in a debit position. Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account. Treasure stock is a good example as it carries a debit balance and decreases the overall stockholders’ equity.
Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset. Allowance for doubtful accounts is contra asset correlation accounts that offset the accounts receivable. They are used in case some customers won’t be able to pay the money they owe to the business. Contra liability accounts are special accounts in the liabilities section of the balance sheet.
Contra asset accounts
In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000. If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries. 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.
Overview: What is a contra asset account?
Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative. 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. A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. 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.
Meaning of contra account in English
CCC estimates that 5% of accounts receivable will most likely be unrecoverable. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
What is a Contra Account? Definition
By reporting contra asset accounts on the 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. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. The example for contra liability accounts includes, discount on bonds payable and discount on notes payable which carry normal debit balances. Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares.
Accounting made for beginners
In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels.
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. The contra asset account carries a credit balance because an asset account usually has a debit balance. Such accounts are allowance for doubtful accounts and the accumulated depreciation account.
The contra accounts will be grouped in the same category on the balance sheet or income statement as their related accounts. Generally speaking, the use of contra accounts is to ensure their related accounts stay clean and to keep track of historical cost easier. The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement. 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.