A company’s financial accounts will usually have three types of items. These include assets, liabilities, and equity. Assets are debit balances that include resources with expected positive future economic benefits.
In contrast, liabilities are credit balances that contain obligations that can result in negative cash flows. Lastly, equity is the residual amount after deducting a company’s assets from its liabilities.
The above accounts are the standard items that a company’s financial statements will include. However, there are other items as well that may not show in those financial statements.
These accounts usually consist of contra accounts. For most companies, the contra asset accounts will also include several types. Before understanding contra asset accounts, it is crucial to learn what contra accounts are.
What is a Contra Account?
A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance. Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance.
For example, if an account has a debit balance, a contra account will have a credit balance. Thus, netting off both will result in the final amount for the account.
Contra accounts are a significant part of a company’s financial statements. These accounts can significantly reduce balances on the balance sheet.
However, the details for contra accounts usually exist on the notes to the financial statements. These accounts do not appear on the balance sheet itself. However, these can cause a reduction in other balances on the statement.
Overall, contra accounts are offsetting balances that are the opposite of specific accounts. There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These are all examples of contra asset accounts, which are the prevalent type of contra accounts.
What is a Contra Asset Account?
A contra asset account is an account that opposes the balances of other asset accounts. As mentioned, a company will usually have debit balances in its asset accounts.
However, a contra asset account usually has a credit or nil balance. This account offsets the balance in the respective asset account that they pair with on the balance sheet.
Contra asset accounts get their name “contra” because they include a credit balance. These go against the normal asset accounts, which have a debit balance.
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.
Although contra asset accounts have credit balances, they do not appear in liabilities or equity. Usually, credit balances include items from one of those two natures. Therefore, contra asset accounts differ from other accounts that have a credit balance. Contra asset accounts are negative assets in essence. However, accounting standards refer to them as contra accounts.
Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets. Similarly, allowance for receivables will pair with accounts receivable balances. These balances cannot offset asset accounts that do not relate to them.
What are the types of Contra Asset Accounts?
Contra asset accounts have several types. Companies don’t need to maintain all these accounts. Instead, the existence of contra asset accounts for companies will differ based on a company’s requirements. However, there are some prevalent contra asset accounts that may exist for all companies. Some of these include the following.
Accumulated depreciation is the most prevalent type of contra asset account. It represents all the depreciation related to an asset or the company’s overall assets. Usually, companies add to the accumulated depreciation account after every accounting period. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements.
The accounting entries for accumulated depreciation are as follows.
Accumulated amortization is an account similar to accumulated depreciation. This account only relates to a company’s intangible assets rather than tangible.
Any company that owns intangible assets such as software, patent, etc., will maintain an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets.
The accounting entries for accumulated amortization are as follows.
Allowance for Receivables
Allowance for receivables is an account that companies maintain to record possible bad debts. However, this account does not represent actual irrecoverable debts.
Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances. This account helps companies present a more accurate accounts receivable balance on the financial statements.
The accounting entries for allowance for receivables are as follows.
|Bad Debt Expense||XXXX|
|Allowance for Receivables||XXXX|
Companies that hold inventories for a long time may face accumulating obsolete inventory. It refers to any items that are no longer relevant or usable.
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 accounting entries for obsolete inventory are as follows.
|Obsolete Inventory Expense||XXXX|
|Obsolete Inventory Reserves||XXXX|
Discount on Notes Receivable
Notes receivables are promissory notes that include a promise from a borrower to repay a lender. For companies, these represent receivables from various parties.
Sometimes, the current value of a note receivable will fall compared to its face value. This process will give rise to a contra asset account which is the discount on notes receivables.
The accounting entries for a discount on notes receivables are as follows.
|Discount on Notes Receivables||XXXX|
A company, ABC Co., purchase a depreciable asset worth $100,000. The company expects the asset to have a useful life of 10 years. ABC Co. records depreciation on a straight-line basis. After each accounting period, the company records a depreciation expense of the asset. The accounting entries for the transaction will be as follows.
In the above example, depreciation is an expense account. On the other hand, accumulated depreciation is a contra asset account. This account will offset the asset’s value by $10,000 each year.
For example, after six years, the asset’s book value on the balance sheet will be $40,000. This amount will include the asset’s original cost of $100,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost.
What is the importance of Contra Asset Accounts?
Contra asset accounts are necessary for companies for various reasons. The most prominent of these include allowing companies to present a more accurate picture of their assets.
Contra asset accounts help companies to record any reductions to their non-current and current assets. By doing so, they can bring their asset accounts to a more accurate position.
Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations. As mentioned, companies do not represent these accounts on the balance sheet. However, they will still appear on the notes to the financial statements with necessary disclosures.
Contra asset accounts also help companies keep their general ledgers organized. By recording reductions in a separate account, companies can get better insights into their actual accounts. Similarly, it allows companies to retrieve original account balances without complicated calculations. For stakeholders, looking at both accounts is also crucial in their decision-making process.
Contra accounts are accounts that offset related accounts. Contra asset accounts are a type of contra account that net off against asset accounts. Similarly, there are several types of these accounts. These include accumulated depreciation, accumulated amortization, allowance for receivables, obsolete inventory, and discount on notes receivables.