Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review.
Definition and Examples of Contra Assets
Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately.
Alternate name: Contra asset account
Both values will be reported on the balance sheet either as separate line items or as a net amount reflecting the value of the associated asset account. Keeping the credits and debits separate in two different accounts allows for more transparent financial tracking and reporting. A key contra asset account commonly found in the general ledger is the accumulated depreciation account, which is a contra account used to reduce the equipment or fixed asset account. Displaying both the fixed asset account and the accumulated depreciation contra account allows a company to clearly report both the historical cost of certain fixed assets and the associated depreciation over the useful life of the items.
How Contra Asset Accounts Work
Contra asset accounts are useful tools in double-entry accounting. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time. Additionally, when the item is sold, the accumulated depreciation associated with it is eliminated from the books, which is much easier to do when these two values are balanced using a contra asset account.
Types of Contra Assets
While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts.
Obsolete Inventory
Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account.
