Despite the use of a minus sign, debits and credits do not correspond directly to positive and negative numbers. When the total of debits in an account exceeds the total of credits, the account is said to have a net debit balance equal to the difference; when the opposite is true, it has a net credit balance.
What are the two methods of accounting for bad debts?
¨ Two methods are used in accounting for uncollectible accounts: (1) the Direct Write-off Method and (2) the Allowance Method. § When a specific account is determined to be uncollectible, the loss is charged to Bad Debt Expense. § Bad debts expense will show only actual losses from uncollectibles.
The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. Obsolete inventory refers to a company’s products or goods that have become obsolete, or unusable, during routine use and operations. This type of contra asset account may generally be debited expenses, followed by a credit to the company’s contra asset account for recording unusable inventory. Similarly, a business may also write off these types of expenses from its financial records if the inventory has been completely phased out.
How To Record A Contra Account
Some balance sheet items have corresponding “contra” accounts, with negative balances, that offset them. Examples are accumulated depreciation against equipment, and allowance for bad debts against accounts receivable. United States GAAP utilizes the term contra for specific accounts only and does not recognize the second half of a transaction as a contra, thus the term is restricted to accounts that are related. For example, sales returns and allowance and sales discounts are contra revenues with respect to sales, as the balance of each contra is the opposite of sales . To understand the actual value of sales, one must net the contras against sales, which gives rise to the term net sales . The contra revenue accounts commonly used in small-business accounting include sales returns, sales allowance and sale discounts. A contra revenue account carries a debit balance and reduces the total amount of a company’s revenue.
Contains the amount of sales discount given to customers, which is usually a discount given in exchange for early payments by customers. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. The totals show the net effect on the accounting equation and the double-entry principle, where the transactions are balanced.
Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Contra RevenueContra revenue refers to any difference between a company’s gross sales and net sales due to sales returns, allowances or discount. In this article, you will learn what a contra asset account is, the types of contra asset accounts a business may have as well as an example of how common types of contra asset account balances are calculated. A contra account is used in a general ledger to reduce the value of a related account when the two are netted together. A contra account’s natural balance is the opposite of the associated account. If a debit is the natural balance recorded in the related account, the contra account records a credit.
Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining. A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. Here, the allowance serves to decrease the receivable balance to its estimated net realizable value. As a contra asset account, debit and credit rules are applied that are the opposite of the normal asset rules. Thus, the allowance increases with a credit and decreases with a debit. The more accounts receivable a company expects to be bad, the larger the allowance.
For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date. Contra asset accounts are used to track everything from depreciation expenses to returned merchandise. Learn what a contra asset is and how you can use these accounts in your small business. It enables a business to record the original value on the general ledger along with any reduction in the value. It allows to see the unique historical value of the assets along with the associated accumulated depreciation. It facilitates easy retrieval of the original amount and the actual decrease, which helps in understanding the net balance.
Know that bad debt expenses must be anticipated and recorded in the same period as the related sales revenue to conform to the matching principle. You don’t have to have a separate depreciation account; you can just post the depreciation amounts directly to the asset account. If you have a separate account, the balance will show the total depreciation taken on the asset; if you post directly the balance will show the current book value of the asset.
A contra equity account reduces the total number of outstanding shares listed on a company’s balance sheet. When a company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account. A company may decide to buy back its shares when management feels the stock is undervalued or because it desires to pay stock dividends to its shareholders. When a company evaluates its financial position, a financial analyst might calculate the total amounts that the company stores in its asset accounts. While financial information on these accounts might include receivables collected, the company can also choose to include its contra asset accounts as a separate line item on the balance sheet. Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.
Understanding Contra Accounts
Debit cards and credit cards are creative terms used by the banking industry to market and identify each card. From the cardholder’s point of view, a credit card account normally contains a credit balance, a debit card account normally contains a debit balance. On the other hand, when a utility customer pays a bill or the utility corrects an overcharge, the customer’s account is credited.
- The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company.
- There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc.
- For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance.
- A transaction is made under the sales return account when a customer returns a product to the company for a refund.
- Here, the allowance serves to decrease the receivable balance to its estimated net realizable value.
- The company projects that the equipment will be usable for six years, and it subtracts a 16% yearly depreciation rate from the initial value to calculate the amount of depreciation over the next six years.
The first known recorded use of the terms is Venetian Luca Pacioli’s 1494 work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita . Pacioli devoted one section of his book to documenting and describing the double-entry bookkeeping system in use during the Renaissance by Venetian merchants, traders and bankers. This system is still the fundamental system in use by modern bookkeepers. Indian merchants had developed a double-entry bookkeeping system, called bahi-khata, predating Pacioli’s work by at least many centuries, and which was likely a direct precursor of the European adaptation.
A company can choose to state this information as separate line items on its balance sheet so that any financial planners or analysts can determine the extent to which a paired asset might be reduced. The book value of an asset is the value of the asset recorded in the company’s balance sheet. Contra accounts are needed for determining the book value of assets held by a company. For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset.
A depositor’s bank account is actually a Liability to the bank, because the bank legally owes the money to the depositor. Thus, when the customer makes a deposit, the bank credits the account (increases the bank’s liability). At the same time, the bank adds the money to its own cash holdings account. But the customer typically does not see this side of the transaction.
Expense Contra Account
A contra asset account is an account that opposes the balances of other asset accounts. As mentioned, a company will usually have debit balances in its asset accounts. This account offsets the balance in the respective asset account that they pair with on the balance sheet. Contra asset accounts are used in relation to a standard asset account and are designed to offset the balance of the account that they’re associated with. Unlike regular asset accounts, which always have a debit balance, contra asset accounts will have a credit balance. Accumulated Depreciation is associated with property, plant and equipment .
Contra accounts have different names depending on the account they correspond. For instance, a contra account that relates to an accounts receivable is called a contra asset account.
Whenever a balance sheet is to be produced, these two accounts are netted to arrive at net realizable value, the figure to be reported for this asset. Understand the reason for reporting a separate allowance account in connection with accounts receivable. DrCrEquipment500ABC Computers 500The journal entry “ABC Computers” is indented to indicate that this is the credit transaction.
This depreciation is saved in a contra asset account called accumulated depreciation. The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment. The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. An accumulated depreciation account is a type of contra asset account that is used for recording the amount of depreciation a fixed asset evolves through. For instance, a fixed asset such as machinery, a company building, office equipment, vehicles or even office furniture would be highlighted in an accumulated depreciation account. This amount may appear on a company’s balance sheet, and it can ultimately result in a reduction in the gross amount of a business’s fixed assets. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue.
We’ll explain in this article what a contra asset account is and how to properly use them. Contra Asset AccountA contra asset account is an asset account with a credit balance related to one of the assets with a debit balance. When we add the balances of these two assets, we will get the net book value or carrying value of the assets having a debit balance. Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet.