Contra asset definition

The equipment is going to provide the company with value for the next 10 years, so the company expenses the cost of the equipment over the next 10 years. Straight-line depreciation is calculated as (($110,000 – $10,000) / 10), or $10,000 a year. This means the company will depreciate $10,000 for the next 10 years until the book value of the asset is $10,000. After two years, the company realizes the remaining useful life is not three years but instead six years. Under GAAP, the company does not need to retroactively adjust financial statements for changes in estimates.

Each year, the accumulated depreciation as a contra asset account increases by $10,000. At the end of five years, for instance, the annual depreciation expense remains at $10,000, whereas the accumulated depreciation will grow to $50,000. 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. Depreciation is the method of accounting used to allocate the cost of a fixed asset over its useful life and is used to account for declines in value. It helps companies avoid major losses in the year it purchases the fixed assets by spreading the cost over several years.

How Contra Asset Accounts Work

Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. Accumulated depreciation is dependent on salvage value; salvage value is determined as the amount a company may expect to receive in exchange for selling an asset at the end of its useful life. Recorded with a debit to Supplies Expense of $650 and a credit to Office Supplies of $650. For tax purposes, the IRS requires businesses to depreciate most assets using the Modified Accelerated Cost Recovery System (MACRS).

• A contra asset account is an asset account with a natural credit balance.
• This results in compliance with the accrual concept while reflecting on an accurate accounts receivable balance.
• Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.
• By separately stating accumulated depreciation on the balance sheet, readers of the financial statement know what the asset originally cost and how much has been written off.
• Accumulated depreciation is used as a contra account while recording depreciation.
• Because the same percentage is used in every year while the current book value decreases, the amount of depreciation decreases each year.

Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset. A contra liability is an account in which activity is recorded as a debit balance is used to decrease the balance of a liability. It is not classified as a liability since how to get backlinks like an seo pro it does not represent a future obligation. An example of a contra asset account is “Accumulated Depreciation.” It is used to record the cumulative amount of depreciation expense charged against a depreciable asset over its useful life. As an asset account, the “Accumulated Depreciation” account has a credit balance, while the related asset account (e.g., “Equipment” or “Buildings”) has a debit balance.

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The outstanding balance of a contra asset account represents a credit figure. These accounts are maintained individually and are adjusted from the corresponding asset’s balance to show the net amount of the assets in financial statements. Accumulated depreciation is an asset account with a credit balance known as a long-term contra asset account that is reported on the balance sheet under the heading Property, Plant, and Equipment. The amount of a long-term asset’s cost that has been allocated, since the time that the asset was acquired. Accumulated depreciation is the total amount that was depreciated for an asset up to a single point. Each period is added to the opening accumulated depreciation balance, the depreciation expense recorded in that period.

A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Under the sum-of-the-years’ digits method, a company strives to record more depreciation earlier in the life of an asset and less in the later years. This is done by adding up the digits of the useful years, then depreciating based on that number of year. It is an account used to decrease the value of the account related to the contra account.

Allowance for doubtful debts accounts

When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. This type of account could be called the allowance for doubtful accounts or bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.

This simply means that accumulated depreciation is the total amount of capital or fixed asset’s cost that has been allocated as depreciation expense from the time that the asset has been used. Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. There are three contra asset accounts that commonly appear in an organization’s chart of accounts.

What Is a Contra Account & Why Is It Important?

Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. Many companies rely on capital assets such as buildings, vehicles, equipment, and machinery as part of their operations. In accordance with accounting rules, companies must depreciate these assets over their useful lives. As a result, companies must recognize accumulated depreciation, the sum of depreciation expense recognized over the life of an asset.

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. Second, on a related note, the income statement does not carry from year-to-year. Activity is swept to retained earnings, and a company “resets” its income statement every year. Meanwhile, its balance sheet is a life-to-date running total that does not clear at year-end.

Overview: What is a contra asset account?

As the depreciation expenses are recorded for an asset or group of assets, the amount of accumulated depreciation will increase over time. Accumulated depreciation is therefore not calculated for the current assets that the company frequently buy and replaces. It is reported on the balance sheet under the asset section, reducing the total value of the capital assets recognized on the financial statement. Hence, accumulated depreciation is reported on the balance sheet, as a contra asset that reduces the net book value of the capital asset section.