Subtract the asset’s salvage value from its purchase price to get the amount that can be depreciated. Some companies may list depreciation for plant, machinery, and equipment separately under the value of each item instead of a cumulative figure used in the above example. Waggy Tails, a pet grooming company, purchases some equipment with a useful life of 10 years for $110,000. Once the useful life of the equipment is over, Waggy Tails can salvage $10,000. The accumulated depreciation of the van will increase by $2,000 for each year of its useful life.

When examining the term “contra asset account,” look no further than the root of contra to get a vague grasp of the definition. Because contra means “against,” one could quickly conclude that a contra asset account is going to be an account that goes against the regular asset account on the Balance Sheet. In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet. More specifically, record the contra asset as a credit that is supposed to balance out a correlating plant asset. The situations that contra asset accounts appear are the ones dealing with Depreciation, which will be explored below. Contra asset accounts are prepared so that an asset’s gross value and deductions can be shown separately. The accounting rules applicable to contra asset accounts are exactly opposite to asset accounts.

What is a Contra Account? Definition

Managers and investors must understand contra accounts to accurately analyze a company’s balance sheet and determine the organization’s financial position. Overall, contra accounts are offsetting balances that are the opposite of specific accounts. There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These are all examples of contra asset accounts, contra asset account which are the prevalent type of contra accounts. The two common contra liability accounts, discount on bonds payable and discount on notes payable, carry normal debit balances. The discount on bonds payable represents the difference between the amount of cash a company receives when issuing a bond and the value of the bond at maturity. Notes payable represents a liability created when a company signs a written agreement to borrow a specific amount of money.

Contra LiabilityA contra liability is a liability account that carries a debit balance as opposed to a credit balance. After each accounting period, the company records a depreciation expense of the asset.

Why are Contra Accounts Important?

You don’t have to, yet even a small business will benefit by using the contra asset account for accounts receivable. This eliminates the need to write off large accounts receivable balances at year end since they’ve already been accounted for. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.

• For her businesses, Nora is responsible for finances, marketing, operations, and fundraising.
• This results in compliance with the accrual concept while reflecting on an accurate accounts receivable balance.
• Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.
• A machine purchased for $15,000 will show up on the balance sheet as Property, Plant and Equipment for $15,000.
• The IRS requires businesses to depreciate specific assets using the Modified Accelerated Cost Recovery System .

Accumulated depreciation is a contra account because it subtracts from the asset. Allowance for doubtful accounts is a contra account because it subtracts from the asset accounts receivable. Accumulated depreciation is an asset account with a credit balance known as a long-term contra asset account that is reported on the balance sheet under the heading Property, Plant and Equipment. The amount of a long-term asset’s cost that has been allocated, since the time that the asset was acquired.

Accumulated Depreciation: Is It Debit or Credit?

The amount recorded in the discount on bonds payable account is amortized to interest expense over the life of the bond. Amortization of the discount on bonds payable account decreases its balance and increases the balance in the interest expense account. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. 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. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.

• A contra account is an account that companies use to reduce the value of a related account.
• Depreciation is the process of spreading the cost of assets over the time they will be in service by the business.
• The total decrease in the value of an asset on the balance sheet over time is accumulated depreciation.
• Business owners should understand the functions of contra accounts and their importance to maintaining accurate financial records.
• Contra asset accounts appear as a credit balance and reduce the value of assets.

The contra asset account is later reduced when the expense is recorded. Business owners should understand the functions of contra accounts and their importance to maintaining accurate financial records. Contra assets are an important bookkeeping concept that helps balance a business’s books. In this article, we look closely at contra assets and the different types of contra accounts you may see on financial statements. Although contra asset accounts have credit balances, they do not appear in liabilities or equity. Usually, credit balances include items from one of those two natures.

A final word about contra asset accounts

Contra asset accounts are credited when these are increased and debited when these are decreased. There are generally two contra asset accounts used by companies that are https://www.bookstime.com/ an allowance for doubtful debts account and an accumulated depreciation account. A liability recorded as a debit balance is used to decrease the balance of a liability.

Still, there are two methods primarily used for the calculation – straight line and double-declining balance. Land does not have accumulated depreciation, because land account is not depreciated.

Definition of Contra Asset Account

ZipBooks gives you the option to create a contra asset account automatically for any new or existing asset account that you mark as depreciable. Accumulated depletion is similar to accumulated depreciation but takes into account the total amount depleted from natural resources. Purchases of oil and gas wells, timber, and fossil and mineral deposits are recorded on a company’s balance sheet as natural resources. These are physically extracted and only replaced by a natural process. Accumulated depletion accounts for the reduction of value in a natural resource.

• Once Freddie accumulated some assets for the business, his office manager Rita told him they would need to set up depreciation for those assets.
• Discount on notes receivable refers to a contra asset account that occurs when the current value of a note receivable amounts to less than the face value of the note.
• Contra asset accounts also help companies keep their general ledgers organized.
• If it is the first year of operation, there is no outstanding balance in the allowance account.
• The estimated useful life of the software is 3 years with no scrap value.
• As mentioned, a company will usually have debit balances in its asset accounts.

Likewise, when you pay a bill, your cash account is reduced because you’re lowering the balance. The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company’s auditors. 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. It appears on the balance sheet as a reduction from the gross amount of fixed assets reported. An allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported to reflect only the amounts expected to be paid. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. When bad debts are incurred, the allowance for doubtful debts would decrease and the accounts receivable would be reduced by that amount.

Types of Contra Asset Accounts and What They Mean

This type of asset account is referred to as “contra” because normal asset accounts might include a debit, or positive, balance, and contra asset accounts can include a credit, or negative, balance. 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. Furthermore, a contra asset account may also be regarded as a negative asset account because equalizing an asset account and contra asset account results in the asset’s net, or total, balance. In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000.

The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. 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. Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them. Accumulated depreciation is the most prevalent type of contra asset account. It represents all the depreciation related to an asset or the company’s overall assets.

Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance.

A company’s financial accounts will usually have three types of items. Assets are debit balances that include resources with expected positive future economic benefits. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited separately. Contra assets may be stated in separate line items on the balance sheet.