What is a Contra Asset Account?
In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance. The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
Normal asset accounts have a debit balance, while contra asset accounts are in 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.
Examples of Contra Assets
Common examples of contra assets include:
Reasons to Show Contra Accounts on the Balance Sheet
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.
Now let’s 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
Assume 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:
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.
Allowance for Doubtful Accounts
Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers that 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.
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:
On the balance sheet, allowance for doubtful accounts reduces the amount of receivables. For example, if Company A reported receivables of $100,000, the journal entry above would reduce the amount of receivables by $5,000. $100,000 – $5,000 (allowance for doubtful accounts) = $95,000 in net receivables.
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