Now, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. Let’s have a deeper understanding of the contra asset vs contra revenue with the help of examples. First of all, we know that when an asset increases it is debited, and when decreases it is credited. So, the accumulated depreciation account which is a contra asset account has a negative balance and it reduces the balance of the asset account. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.
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. 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. 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. A contra liability account is a liability account that is debited in order to offset a credit to another liability account. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.
What Is a Contra Account?
After having elaborated examples of contra asset and contra revenue account it has become easier to understand the difference. 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.
A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance. Two common contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect. Allowance for doubtful accounts offsets a company’s accounts receivable account. Accumulated depreciation offsets a company’s real property assets, such as buildings, equipment and machinery.
How Contra Asset Accounts Work
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 an allowance for doubtful debts account and an accumulated depreciation account. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts.
This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. A customer returned $100 worth of items, claiming them to be defective. The annual amortization of the cost of an asset is referred to as depreciation expense. The corresponding effect is charged to accumulated depreciation accounts. Accumulated depreciation accounts accumulate the depreciation expense charged on the asset. In general, accounts receivable are converted into cash within the operating cycle. This is treated as loss during the period, also called bad debt expense.
Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset. The contra revenue accounts commonly used in small-business accounting include sales returns, sales allowance and sale discounts.
- Apart from these differences, there are some similarities between both accounts.
- The amount is reported on the balance sheet in the asset section immediately below accounts receivable.
- For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due.
- The sales allowance shows the discounts given to customers when returning the product.
- A customer returned $100 worth of items, claiming them to be defective.
The December 5th journal entries record the original sale, and the December 12th entries record the return and exchange. Inventory is updated with the debit entry and the cost of goods sold https://www.wave-accounting.net/ is reduced with the credit. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account.
There are three contra asset accounts that commonly appear in an organization’s chart of accounts. It is paired with the trade accounts receivable account, and contains a reserve for receivables that are unlikely to be paid by customers. By combining the balances in these two accounts, one can determine the net amount of receivables that the reporting entity expects to receive. The size of the reserve also reveals the amount of bad debt that the company expects to experience from the current set of receivables.
In accounting, assets are things of value that your business owns. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
Therefore, the book value of an asset in the books is equal to its historical cost minus the related amount of contra asset in the balance sheet . A contra asset account is an account in the balance sheet that offsets the balance of a regular asset account. Allowance for doubtful debt is a contra account against which bad debts are charged. The journal entry is reversed as and when bad debts are recovered. When bad debts are incurred, the allowance for doubtful debts would decrease and the accounts receivable would be reduced by that amount. In this method, bad debt expense is estimated for the period and is recorded as an expense while the allowance account is credited.
The Johnson family is expecting visitors for the holidays and will need to furnish the spare bedroom. They find a nice set at Homes Inc. that includes a queen size bed, dresser, nightstand, and luggage rack. However, if the billing office stopped there, you would overstate your assets and net income. You must also report the amount that you can reasonably expect will not be paid, if it is estimable and probable. You could simply adjust the parent account…but then you are missing an essential part of the story — how many patients were actually treated today for a sprain. To report the real value of the financial statement, you will need to record the amount you can reasonably estimate that will probably effect the financial statement classification.