Expenses are the costs of doing business, but not all costs are expenses. In accounting terms, an expense is a cost incurred to produce revenue reported on the income statement. If you buy a pair of shoes from your supplier for $20, that’s a cost, but it’s not yet an expense. That’s because, as far as accounting is concerned, you haven’t really “spent” $20. You’ve just converted $20 worth of cash into $20 worth of shoes; an asset that remains in your inventory.
Accumulated depreciation is the counterpart of depreciable assets. Companies that hold inventories for a long time may face accumulating obsolete inventory. A $400 credit to Prepaid Insurance and an $800 debit to Interest Payable. Contra Accountmeans the account against which the Control Account’s balances settled as per the parameters defined for that Control Account.
This account appears on the asset side of the balance sheet as a reduction from the fixed assets. 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. 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.
Examples of contra accounts include Allowance for Doubtful Accounts, Accumulated Depreciation, and Return on Sales. The Johnson family’s purchase of furniture illustrated the effect on the financial statements for two kinds of contra accounts, revenue, and asset. When this happens, the debit will be added to the expense account Bad Debt Expense and the credit will be added to the asset account, Allowance for Doubtful Accounts. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. For example, GAAP accounting requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used.
Quite frankly, the actual definition is not far from this estimate. In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet. More specifically, record the contra asset as a credit that is supposed to balance out a correlating plant asset. The situations that contra asset accounts appear are the ones dealing with Depreciation, which will be explored below.
For example, the debit will be to the expense account in an estimated uncollectible amount from a credit sale. The credit will be to the asset account or allowance for doubtful accounts. Contra revenue accounts show the deducting adjustments to gross revenue or producing net revenue. Sales returned for a refund are posted to the contra account to reduce gross revenue or return on sales. The other side of the transaction is posted to cash because there is no value in retaining the sales transaction in the cash account.
Contra Account Journal Entry:
The most commonly used contra account is accumulated depreciation. Displaying explanations in this manner is thought to be advantageous when compared to other communication methods such as supporting schedules or notes that might accompany the statement. However, it will be meaningless to show the property plant and equipment cost account and the related accumulated depreciation account separately on the balance sheet. We need to show the net book value of the property plant and equipment which equals the cost of PPE offset by related accumulated depreciation which is a contra account. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. Sometimes, the current value of a note receivable will fall compared to its face value.
Contra assets allow for more granular visibility on the balance sheet by maintaining historical costs and independent values rather than reducing the original account directly. Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. Outstanding SharesOutstanding shares are the stocks available with the company’s shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner’s equity in the liability side of the company’s balance sheet. The discount offered on the liability created when a company borrows a specific amount of money and repays it early. Discount on notes payable reduces the total amount of the note to reflect the discount offered by the lender.
Examples of Contra Asset Accounts
Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. Therefore, a contra asset account will show the opposite balance – the credit balance. A contra asset account includes contra accounting definition allowance for doubtful debt accounts and accumulated depreciation accounts. An accumulated depreciation account is used to record depreciation of fixed assets of a company such as land, machinery, equipment and buildings.
- This account is not classified as an asset since it does not represent a long-term value.
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- When this happens, the debit will be added to the expense account Bad Debt Expense and the credit will be added to the asset account, Allowance for Doubtful Accounts.
- But for presentation purposes it is sometimes necessary to show net balance of two accounts.
- Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.
- Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value.
What is an example of a contra expense account?
Contra expense accounts have a credit balance rather than the debit balance, which is normal for expense accounts. Some examples of contra expense accounts include expense reimbursements, purchase returns account, purchase discounts account and purchase allowances accounts.