Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s contra account balance and the contra account asset balance is the book value. For example, when a line item on your balance sheet presents the balance of accounts receivable, report the value of allowance of uncollectible accounts below the accounts receivable line.

How to Estimate the Allowance for Doubtful Accounts

Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation.

Contra Liability Account: What it is, How it Works, Example

• The first step in accounting for the allowance for doubtful accounts is to establish the allowance.
• For the purpose of financial statement reporting, the amount on a contra account is subtracted from its parent account gross balance to present the net balance.
• The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
• If you debit the contra account, ensure that you offset the related account with a credit balance.
• The matching principle states that revenue and expenses must be recorded in the same period in which they occur.
• For example, after six years, the asset’s book value on the balance sheet will be $40,000.
• Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.

Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. The contra asset account of your equipment account is the accumulated depreciation of equipment. When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000.

Obsolete Inventory

Companies technically don’t need to have an allowance for doubtful account. If it does not issue credit sales, requires collateral, or only uses the highest credit customers, the company may not need to estimate uncollectability. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. For industries that rely on natural resources — mining, logging, oil, gas — depletion tracks the gradual exhaustion of the raw material in question, offsetting that loss in value against the initial appraisal of the land.

• Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.
• Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances.
• This type of account could be called the allowance for doubtful accounts or a bad debt reserve.
• In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account.
• In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed.

However, these vehicles have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand. Note that if a company believes it may recover a portion of a balance, it can write off a portion of the account. Get instant access to video lessons taught by experienced investment bankers.

• Still, it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts.
• Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period.
• The most prominent of these include allowing companies to present a more accurate picture of their assets.
• A contra account is an account used in a general ledger to reduce the value of a related account when the two are netted together.
• The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400.
• Examples of a contra revenue accounts include sales returns, sales discounts, and sales allowances.
• The sales method applies a flat percentage to the total dollar amount of sales for the period.

The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate. 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. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. While tracking contra asset accounts is cumbersome for bookkeepers and accounting clerks using manual accounting systems, if you’re using accounting software you’ll find that most of the heavy lifting is done for you. You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity.

This account helps companies present a more accurate accounts receivable balance on the financial statements. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance. Both of these accounts offset each other to represent a net balance on a company’s balance sheet. However, the details for contra accounts usually exist on the notes to the financial statements. Then, the company establishes the allowance by crediting an allowance account often called ‘Allowance for Doubtful Accounts’. Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets.

Contra Account