How Contra Asset Accounts Impact Your Financial Statements

Often when a company extends goods contra asset account on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. An unfortunate reality of doing business is that not all accounts receivable will be paid. By estimating the value of accounts receivable that may result in bad debt, a company can better estimate future lost revenue and develop a clearer understanding of future cash flows. This helps in creating a more accurate and realistic outlook for future receivables and safeguards against the overestimation of the value of accounts receivable. Instead of reporting the net sales on the income statement directly, the sales returns are shown as well.

Presentation of Contra Accounts

Well, contra asset accounts give us a clearer picture of the real value of assets. By providing a clear and transparent mechanism to account for adjustments, these accounts enable stakeholders, including investors and creditors, to better understand a company’s financial health. For instance, “Sales Returns and Allowances” is a contra account entry used to record returned merchandise or customer allowances, allowing a company to track and report these adjustments separately from regular sales revenue. A contra account is an essential concept in financial accounting that serves to offset the balance of another account. It plays a vital role in maintaining the accuracy and transparency of a company’s financial statements.

Tricky Question: Is Unearned Revenue a Contra Account?

Instead of adjusting the main asset account, you record reductions separately. Contra asset accounts track adjustments like depreciation, allowance for doubtful accounts, and discounts. For example, if you record depreciation, you debit depreciation expense and credit accumulated depreciation in the contra-asset account. If a customer returns a product, you debit sales returns and allowances and credit accounts receivable.

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. 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. Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired. Instead of increasing assets or decreasing liabilities (as would be typical when spending cash), buying treasury stock reduces shareholders’ equity.

To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s balance sheet. 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. Nowadays, with the development of a computerized accounting system, it is easy and quick to prepare the contra asset accounts as the system does all the calculations, and hardly anything is pushed manually.

Step 1: Identify the contra account type

Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. 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. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. For example, a company made sales of $60,000 but goods worth of $2,000 were returned due to damage.

We and our partners process data to provide:

A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. 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.

Contra asset accounts are a type of contra account that net off against asset accounts. These include accumulated depreciation, accumulated amortization, allowance for receivables, obsolete inventory, and discount on notes receivables. Contra asset accounts are an integral part of understanding and managing a company’s overall financial health, but they can seem counter-intuitive and difficult to grasp if you don’t have a strong background in accounting. These less-frequent contra accounts come into play when you need to account for changes in the outstanding liabilities for your business. For example, when your company borrows money, you would identify that debt in a Notes Payable account. Furthermore, if you subsequently pay off that debt early and capture a discount, the contra liability account — Discount Notes Payable — would record those savings.

• It is only prudent to show the reduction or reserve in a separate account, and at any point, it gives us the netbook value explaining what the actual cost was and how much of that has been depreciated.
• Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods.
• Contra accounts exist because different financial elements, like assets, liabilities, equity, and revenue, need adjustments for accurate reporting.
• They adjust account balances without erasing the original transaction data.
• He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.

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. Companies that hold inventories for a long time may face accumulating obsolete inventory. 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).

Contra Asset Account Definition

Tracking reductions separately gives you a clearer view of your asset value and overall financial health. 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. A contra account provides missing context by pairing it with a related account. So as values shift depending on real-world factors, rather than making deductions or adjustments to the original or “parent” account, you would record these changes in the contra account instead.

When your company buys back its own shares, you record the cost in a contra equity account. These shares no longer count as outstanding and do not pay dividends. A contra-equity account reduces the total value of your company’s equity. Instead of adjusting the main equity account, you record reductions separately. Companies rely on accountants and financial controllers to manage contra accounts. These professionals ensure that records accurately reflect a business’s financial health.

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. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. 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. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.

You use these accounts to adjust debt and show the true amount your business owes. Instead of lowering the main liability account, you record the reduction separately. You record the decline in value in a contra-asset account instead of changing the original asset value.

Over time, though, the car loses value due to wear and tear—a process we call depreciation. The depreciation doesn’t reduce the car’s original cost on the books. Instead, we use a contra asset account called Accumulated Depreciation to track how much value the car has lost. 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 transparency is essential for investors, creditors, and anyone else evaluating the company’s financial health.
• On the other hand, accumulated depreciation is a contra-asset account.
• Instead of reporting the assets at their carrying amount directly, assets are reported at their historical costs and are reduced to book value by reporting the allowance for depreciation along with it.

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. Strong financial reporting helps you present a true and reliable picture of your business’s financial health. They prevent overstated revenue, inflated assets, and misleading liabilities, ensuring that your financial statements reflect real values. A contra-liability account reduces a liability instead of increasing it.

He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. When the two balances are offset against each other they show the net balance of both accounts. Mark is an accounting and finance professional with over a decade of experience in public accounting and consulting. As both an accountant and entrepreneur, he is passionate about helping clients strategically organize and grow their businesses to reach their goals.

So, in this case, accumulated depreciation is a contra asset account related to plant & equipment. With increasing globalization and companies operating in many countries, the books of accounts must be compatible with a global platform. They are also the result of globally accepted accounting principles for accurately reporting financial numbers.