- Accumulated depreciation.
- Accumulated depletion.
- Obsolete inventory reserves.
- Allowance for doubtful accounts.
- Trade accounts receivable.
- Discount on notes receivable.
Contra accounts explained
Types of contra asset accounts
The following six types of contra asset accounts can be used in conjunction with these fixed and current asset accounts and other asset types that a company may use in combination.
1. Accumulated depreciation
The amount of depreciation a fixed asset experiences is recorded in an accumulated depreciation account, a type of contra asset account. An accumulated depreciation account, for instance, would draw attention to a fixed asset such as machinery, a company building, office furnishings, vehicles, or even office equipment. The gross value of a company’s fixed assets may be reduced as a result of this amount, which may appear on the balance sheet of the business.
2. Accumulated depletion
Another popular type of contra asset account called “accumulated depletion” enables a business to track the amount of depletion costs it has racked up over time for the use of tools, equipment, and other resources used in its processes and operations. Usually, this sum appears on the balance sheet with the company’s current assets.
3. Obsolete inventory reserves
During routine use and business operations, a company’s products or goods can become obsolete or useless. Typically, expenses of this kind can be debited, then the company’s contra asset account can be credited to reflect unusable inventory. Similar to this, if the inventory has been completely phased out, a business may also write off these kinds of expenses from its financial records. A financial analyst can determine the current market value of the company’s inventory by combining the contra asset account with a current inventory account.
4. Allowance for doubtful accounts
A type of contra asset account called an “allowance for doubtful accounts,” or “ADA,” is used to set aside money for customers who buy goods or services but later fail to pay the balance owed on those purchases. The allowance for doubtful accounts may also be shown on a company’s balance sheet, and it may cause the total amount of receivables to decrease.
5. Trade accounts receivable
Trade accounts receivable are sums that a business bills customers for when providing goods or services. The majority of the time, these billings are noted on invoices, which are then compiled in an aging report for all of the company’s accounts receivable.
6. Discount on notes receivable
When a note receivable’s current value is less than its face value, a contra asset account known as “discount on notes receivable” is created. Over the course of the note’s useful lifetime, the resulting credit balances in these kinds of accounts can typically be amortized as interest income.
What is a contra asset account?
An asset account known as a contra asset is one in which the balance may be either negative or zero. Because contra asset accounts can have a credit, or negative, balance instead of a debit, or positive, balance, this type of asset account is known as a “contra” asset account. The contra account functions as a contrary element to the debit balances of regular asset accounts because of the oppositional nature of these asset accounts. Because equalizing an asset account and a contra asset account results in the assets’ net, or overall, balance, a contra asset account may also be viewed as a negative asset account.
On a company’s balance sheet, this type of account can balance the balances in the asset account it is paired with. Credited balances in the contra asset account have the potential to lower the balance in its paired asset account. Any financial planners or analysts can determine the extent to which a paired asset might be reduced if a company chooses to disclose this information as separate line items on its balance sheet.
Reasons to include contra asset accounts on a balance sheet
It can still be beneficial for businesses to show any contra asset accounts they currently have within their balance sheets, even though a contra asset account shows negative or zero balances in credits within the account. The following are a few major justifications for why contra asset accounts may be crucial to include on a balance sheet.
Examples
The examples below demonstrate how a business might draw attention to and determine the balance within two of the most popular types of contra asset accounts, an allowance for doubtful accounts and an accumulated depreciation account.
Example accumulated depreciation
Power Manufacturers, Inc. purchases new machinery for a total of $300,000. In order to determine the amount of depreciation over the following six years, the company assumes that the equipment will be usable for six years and subtracts a 16% annual depreciation rate from the initial value. As a result, for every year that the equipment is used, its depreciation increases by about $50,000. This method calculates the equipment’s final value after use by starting with the initial purchase price and deducting the amount of depreciation that has accrued over time.
Power Manufacturers, Inc.’s accumulated depreciation would rise each year on the balance sheet over the course of six years, lowering the value of the equipment it bought. It may look something like this:
Allowance for doubtful accounts
Now let us say that Power Manufacturers, Inc. It estimates that 5% of all credit sales made in the previous quarter will not be paid for, and reports its total credit sales for the quarter at $100,000. The allowance for doubtful accounts can lower the totals in the company’s accounts receivable on the balance sheet. The estimated 5% default rate would therefore result in a $5,000 decrease in the amount of accounts receivable if the company reported receivables totaling $100,000.
In addition, even though they have not yet received payment on credit sales, the company may use the percentage found in the allowance for doubtful accounts to determine the total value of its receivables:
Net Receivables: $100,000 – $5,000 (the 5% allowance for doubtful accounts), or $95,000.
As more credit sales come in, Power Manufacturers may change this calculation in their financial records, bringing the company’s total value of receivables down to $95,000.
Types of finance and accounting jobs
If you have experience with various contra asset account types, consider one of the following career paths in the finance sector:
FAQ
What are the 2 contra asset accounts?
Let’s now concentrate our efforts on the two most popular contra assets: accumulated depreciation and allowance for doubtful accounts.
What are the contra accounts in accounting?
A contra account cancels out the balance of the related account it is paired with. In the financial statements, contra accounts are displayed next to their paired accounts. Sometimes, for presentational reasons, the balances in the two accounts are combined, leaving only a net amount on the screen.
