Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account.
The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported. The net amount https://www.wave-accounting.net/what-is-the-average-cost-of-bookkeeping-services/ is often referred to as the carrying amount or perhaps the net realizable amount. Contra asset accounts also help companies keep their general ledgers organized.
Contra Asset, Contra Liability and Contra Equity
The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. Machinery, physical space, equipment, vehicles, etc., are some examples of common fixed assets.
Contra asset accounts have a credit balance as compared to a debit balance that most other types of accounts have. Before we start talking about the finer details, it’s important to know what is a contra asset account. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds.
How Contra Asset Accounts Work
The accounting entries for accumulated depreciation are as follows. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.
Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. The allowance for doubtful accounts is a general ledger account that is used to estimate the amount of accounts receivable that will not be collected. A company uses this account to record how many accounts receivable it thinks will be lost. Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet. This type of account is a contra asset that reduces the amount of the gross accounts receivable account.
Allowance for doubtful accounts
Companies technically don’t need to have an allowance for doubtful account. If it does not issue credit sales, requires collateral, or only uses the highest credit customers, the company may not need to estimate uncollectability. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers.
- When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.
- The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet.
- Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.
- Offsetting the asset account with its respective contra asset account shows the net balance of that asset.
- We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R).
This improvement in the accounting details and transparency is good for any business in multiple ways. These accounts might also appear on the balance Accounting for Startups The Ultimate Startup Accounting Guide sheets of the company. In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later.