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Contra Asset

An asset account in which the account's balance will either be a zero or a credit (negative) balance

What is a Contra Asset Account?

In bookkeeping, a contra asset is an asset account in which the balance of the account will either be a zero or a credit (negative) balance. A contra asset account offsets the balance in the respective asset account that it is paired with on the balance sheet.

A normal asset account includes a debit balance, while a contra asset account includes a credit balance. Therefore, a contra asset can be regarded as a negative asset account. Offsetting the asset account with its respective contra asset account shows the net balance of that asset.

 

Contra Asset - Diagram

 

 

Examples of Contra Assets

Common examples of contra assets include:

  • Accumulated depreciation
  • Allowance for doubtful accounts
  • Reserve for obsolete inventory

 

 

Reasons to Show Contra Asset Accounts on the Balance Sheet

By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the 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.

Now, we will focus our attention on the two most common contra assets – accumulated depreciation and allowance for doubtful accounts.

 

Contra Asset – Accumulated Depreciation

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.

 

Example of Accumulated Depreciation

For example, Company A purchases a machine for $300,000. The company estimates that the machine’s useful life is three years with no salvage value and will apply a straight-line depreciation method to the machine. The journal entries will look as follows:

 

Contra Asset Account - Accumulated Depreciation

 

Accumulated Depreciation - Example 2

 

Accumulated Depreciation - Example 3

 

Accumulated Depreciation - Example 4

 

On the balance sheet, accumulated depreciation would increase by every year to reduce the value of the machine. Therefore:

  • At the end of year 1, the net value of the machine would be $300,000 – $100,000 in accumulated depreciation = $200,000.
  • At the end of year 2, the net value of the machine would be $300,000 – $200,000 in accumulated depreciation = $100,000.
  • At the end of year 3, the net value of the machine would be $300,000 – $300,000 in accumulated depreciation = $0.

 

Contra Asset – Allowance for Doubtful Accounts

Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers that do not pay the money owed. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.

 

Example of Allowance for Doubtful Accounts

For example, Company A uses the percentage of credit sales method and estimates that 5% of credit sales will default. The company reported credit sales of $100,000. The journal entry would look as follows:

 

Allowance for Doubtful Accounts - Example

 

On the balance sheet, allowance for doubtful accounts would reduce the amount of receivables. For example, if Company A reported receivables of $150,000, the journal entry above would reduce the amount of receivables by $5,000. $150,000 – $5,000 (allowance for doubtful accounts) = $145,000 in net receivables.

 

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Three Financial Statements
  • PP&E (Property, Plant & Equipment)
  • Straight-Line Depreciation Method
  • Credit Sales

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