These accounts are created specifically for the reason to be able to decrease the amount reflected in a corresponding account in an indirect way. Double-entry accounting plays an important role in the way bookkeepers record each and every transaction. Based on this equation, each account in the general ledger has a debit or a credit normal balance, which is used to identify whether an account should be debited or credited to increase its balance. Accounts Receivable is an asset account that represents the amount of money due to a business for goods or services that have been delivered or used but not yet paid for by customers. Contra asset accounts also provide a clear picture of the companies’ accumulation of assets.

Is Premium on Bonds Payable a Contra account?

Another example is for industries that rely on natural resources such as mining, oil, gas, or logging, the depletion process is used to track the extraction of the natural resource, which is gradually exhausted over time. This process calculates the decline in value of the natural resource and offsets it against the initial appraisal of the land where the resource is being extracted from. Provision for a discount from creditors and discount on bills receivable are other widely used examples. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching.

To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value. A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset. To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together.

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 equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period.

• The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount.
• So an Accumulated Depletion account would serve as the contra for the parent Fixed Asset account.
• The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.
• This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.
• A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset.

1. Owner’s Drawing Account Equity Contra

Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing. If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $10 thousand in discounts during that same timeframe. In reality, the actual number of company discounts came closer to $5 thousand. These accounts can be listed based on the respective asset, liability, or equity account to reduce their original balance. They are crucial for compliance with generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS).

In bookkeeping terms, a contra asset account refers to an account which is offset against an asset account. If you’re valuing a low-growth company based on its equipment contra asset 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.

Contra Asset Account Explained

In other words, contra revenue is a deduction from gross revenue, which results in net revenue. The points below explain the importance of passing a contra account entry. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

How are contra accounts recorded?

Accurate contra account use also smoothes out budget forecasting and financial planning, as businesses are not caught off-guard by suddenly realized losses or overstated assets. Baking in room for bad debt, asset depreciation, and returned goods means fewer surprises and more confident stakeholders. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger.

• In this scenario, a write-down is recorded to the reserve for obsolete inventory.
• Contra asset accounts also provide a clear picture of the companies’ accumulation of assets.
• For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets.
• A contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together.

A contra asset is a negative asset account that offsets the asset account with which it is paired. The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. By stating this information separately in a contra asset account, a user of financial information can see the extent to which a paired asset should be reduced. A sample presentation of a contra asset appears in the following exhibit, where the accumulated depreciation line item offsets the total fixed assets line item; this presentation shows the fixed asset detail within a balance sheet. However, the “Allowance for Doubtful Accounts” (or “Allowance for Uncollectible Accounts”) is a contra account related to the concept of bad debts.

Cash Flow Statement

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. Similarly, allowance for receivables will pair with accounts receivable balances. The Notes Receivable account documents the total value of any promissory notes held by the company. Typically, these notes reflect purchases made on credit by your customers.

Income Statement

Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account. This requirement also comes from the accounting standard for inventories. The net of the asset and its related contra asset account is referred to as the asset’s book value or carrying value.

Contra liabilities are common in companies that sell bonds to raise capital. For example, a bond with a principal amount of $1,000 may be sold for only $950. The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings.

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. Contra revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances. For instance, when a company buys back their own shares, they register them in a ‘Treasury Stock’ contra equity account, which reduces total shareholders’ equity.

Accumulated amortization is an account similar to accumulated depreciation. This account only relates to a company’s intangible assets rather than tangible. And let’s not forget the all-important Allowance for Doubtful Accounts, acting as a financial crystal ball that estimates the portion of accounts receivable that might just turn into fairy dust. Businesses benefit by forecasting more realistic revenue figures, which helps in strategic planning and maintaining investor confidence. Now, if that sounded like a lot of mumbo-jumbo jargon to you, don’t worry.