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. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount.

Namely, inventory accounting allows businesses to assess where they may be able to increase profit margins on a product at a particular place in that product’s cycle. The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Contra asset accounts provide business owners with the true value of certain asset accounts.

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2. Since inventory is an asset, it affects the overall value of the company.
3. The principles of conservative accounting prescribe reporting assets as close to their current value as possible.
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For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.

Contra revenue account

Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement.

This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. To oppose the revenue made by a company, contra revenue accounts must have a debit balance. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability.

Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.

What Is a Contra Account?

One case is when inventory turnover levels are extremely high for all items, so that inventory rarely stays on the shelf for long. Another case is when inventory is so subject to spoilage that older items will probably be thrown out before they https://www.online-accounting.net/home-office-expense-home-office-tax-deductions-for/ could impact the contra account. A good example is a restaurant, where the staff will likely inspect the inventory every few days and throw out spoiled items. There are several situations in which a contra inventory account can be used.

Asset accounts usually have a positive value which is the same as a debit balance. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances.

One is when market prices are lower than inventory costs, which will trigger a lower of cost or market adjustment. It is also useful when inventory is quite old or turnover levels are low. A third possible use for the account is when some of the inventory net purchases is calculated by taking the cost of new inventory purchases plus freight is no longer listed in the bills of material for current products, and so will not be used. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts.

Contra asset accounts journal entries

A contra inventory account is a general ledger account with a credit balance. The credit balance in the contra inventory account will be combined with the debit balance in the inventory account when a balance sheet is prepared. 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. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.

This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory. 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. The main advantage of inventory accounting is to have an accurate representation of the company’s financial health. However, there are some additional advantages to keeping track of the value of items through their respective production stages.

A key example of contra liabilities includes discounts on notes or bonds payable. 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.