This account offsets the gross revenue to reflect that not all sales result in final transactions. If a company records contra asset account definition $200,000 in revenue but then issues $10,000 in sales allowances and returns, the net revenue would be $190,000. The calculated bad debts expense affects the income statement by recognizing an expense related to receivables that are unlikely to be collected. Concurrently, an allowance for doubtful accounts is established or adjusted, which is a contra-asset account that offsets the accounts receivable balance on the balance sheet.
Is a Contra Account a Debit or Credit?
Subscription-based bookkeeping services are transforming the way businesses manage their finances, offering predictable pricing, scalability, and automation-driven efficiency. Instead of paying hourly or hiring in-house staff, businesses can now access professional bookkeeping on a fixed monthly or annual subscription model. Accumulated depreciation is considered a contra asset because it contains the cumulative total of all depreciation expense recognized on an asset to date. Rather than altering the original cost of the asset, it serves to reduce the asset’s value on the balance sheet, thus representing the asset’s declining value over its useful life. Property, Plant, and Equipment (PP&E) and Accumulated DepreciationAnother key example involves property and equipment. When a business owns assets like machinery, the value of these assets decreases over time.
What is a Contra Account? Definition
Under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), these accounts adjust the gross amounts of assets, liabilities, and equity for accurate net values. The following are examples of commonly-used contra asset accounts you could create to better understand your business financials. However, it’s important to keep in mind that you can create any contra account you want to more clearly describe your business — this is not an exhaustive or definitive list. Contra accounts exist because different financial elements, like assets, liabilities, equity, and revenue, need adjustments for accurate reporting. Instead of modifying the main accounts directly, businesses use contra accounts to track reductions, risks, or expected losses.
What are Contra Accounts?
In order to account for such allowances, the company will debit the contra sales account Sales Allowances for $10,000 (instead of debiting Sales) and credits Accounts Receivable. The company will likely combine the credit balance of $900,000 in the Sales account with the debit balance of $10,000 in the Sales Allowances account and report net sales of $890,000. When a listed company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account. A company may take the decision to buy What is bookkeeping back its shares when management feels the stock is undervalued or because it desires to pay stock dividends to its shareholders. A contra revenue account is a revenue account that is expected to have a debit balance (instead of the usual credit balance). In other words, its expected balance is contrary to—or opposite of—the usual credit balance in a revenue account.
Contra assets
This adjustment is vital for investors and analysts evaluating a company’s debt obligations and interest expenses. Record Keeping for Small Business The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. 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.
- By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
- This account helps companies present a more accurate accounts receivable balance on the financial statements.
- By estimating potential losses before they occur, companies present a more honest picture of their financial health while properly matching expenses to the periods when they earn revenue.
- A good example is a restaurant, where the staff will likely inspect the inventory every few days and throw out spoiled items.
- A contra revenue account offsets a revenue account, which typically has a credit balance.
Example of a contra account
Instead of recording deductions as expenses, you track them separately to keep your sales figures accurate. This prevents inflated revenue numbers and gives a clear picture of your net earnings. Treasury stock is a contra equity account that is used to offset the balance of the common stock account.
- A contra account is an account in the general ledger that offsets the balance of a related account, known as its paired account.
- The accumulated depreciation account is designed to reduce the carrying value of the fixed asset account when depreciation is recorded at the end of each period.
- We get the remaining value of assets by deducting the accumulated depreciation balances from the book value of the asset.
- 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.
- Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes.
Contra Liability Account: What it is, How it Works, Example
Both of these accounts offset each other to represent a net balance on a company’s balance sheet. The company estimates that it will not be able to collect 1,000 from its customers. The allowance for doubtful accounts is a contra asset account that is used to offset Accounts Receivable on the balance sheet. Below is the asset account debit balance and accumulated depreciation account credit balance on the balance sheet.