Contra Asset

What Is A Contra Asset Account?

A contra asset account is an account in the balance sheet that offsets the balance of a regular asset account. It typically has a negative (credit) balance.

Asset accounts have a debit balance. However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset.

Note that in accounting, the term “book value” is also used interchangeably with net value. Therefore, the book value of an asset in the books is equal to its historical cost (the debit balance of the asset) minus the related amount of contra asset in the balance sheet (the credit balance of the contra asset).

Other less commonly used terms for contra asset accounts are valuation accounts and valuation reserves. Valuation accounts, however, can also be contra accounts for other items in the balance sheets, like liabilities.

Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities.

The most common contra asset accounts used in the books are:

1. Accumulated depreciation is the counterpart of depreciable assets.

2. Allowance for doubtful accounts, the counterpart of accounts receivable.

3. Accumulated depletion is the counterpart of natural resource assets.

4. Reserve for obsolete inventory, the counterpart of inventories.

Contra Asset Accounting & Examples

The definition can be expanded to include contra accounts in general. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. 

Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values.

Whenever the balance of an account needs to be reduced in a company's ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. 

Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account.

Having contra accounts can serve multiple purposes, both for the company and for the users of the company's financial statements:

• They can present more information about the assets and liabilities of the company. Such information includes the purchase cost of an asset (historical cost), the amount of depreciation written off for that asset, etc.

• They can indicate how certain assets or liabilities are performing throughout the years. Contra accounts do that by preserving the purchase and acquisition costs of their corresponding accounts and disclosing any deduction in their balances.

There are different types of contra accounts. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. 

Contra asset accounts

As mentioned, contra asset accounts usually have a negative value which is the same as a credit balance. That is to completely or partially offset the balance of their related asset accounts. Asset accounts usually have a positive value which is the same as a debit balance.

By having the balance of both accounts, it is quite straightforward to calculate the net value of an asset:

Net Asset Value = Asset Account Balance - Contra Asset Account Balance.

Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost.

For example, an asset was purchased by a company for $100,000 - that is, the historical cost of the asset was $100,000 - and its contra asset counterpart has a balance of $30,000. Therefore, the asset's net value (or the book value) will be $70,000.

In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000. If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries.

Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset's net value or book value. 

Sometimes, both accounts can be written in a single line if they don't represent a large portion of the assets. In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed.

Whenever the balance of a contra asset account increases (credit to the contra asset account), the increased amount is written off as an expense and is reported in the company's income statement.

For example, if the balance of accumulated depreciation increases from $20,000 to $50,000, this means that the depreciation expense amounts to $30,000, which will be listed in the income statement.

A company’s comptroller (the person who takes over the company’s accounting operations) may differ from the company’s auditor (the person who ensures that the firm is preparing its financial statements according to financial reporting rules regarding the size of the firm’s contra asset accounts.

The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels.

Contra liability accounts

Contra liability accounts are special accounts in the liabilities section of the balance sheet. They aim to reduce the balance of some related liability accounts. This would let users of the financial statements calculate the book value of the liability.

Net Liability Value = Liability Account Balance - Contra Liability Account Balance.

Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart.

Crediting a liability account will always increase its balance while debiting a liability account will always decrease its balance. That is why contra liability accounts have a debit balance: to reduce the value of its corresponding liability account.

The most important contra liability accounts are:

1. Discount on bonds payable

2. Discount on notes payable

Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable.

If a company sells a bond at a discount, the difference between the cash received and the value of the bond it sold will be listed as “discount on bonds payable,” which is a contra liability account, the counterpart of bonds payable.

For example, a firm sold five bonds, each worth $1,000. But it sold them for $900 each. This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders.

The difference, which is $500, is thus listed as a discount on bonds payable and is debited to the contra liability account “discount on bonds payable.”

In summary, the company records in its books:

• $4,500 debit to cash (asset account)

• $5,000 credit to bonds payable (liability account)

• $500 debit to discount on bonds payable (contra liability account)

Note that every journal entry includes both a debit and a credit. Moreover, the two sides must be exactly equal to each other to preserve the fundamental accounting equation:

Assets = Liabilities + Owners’ Equity.

Contra equity accounts

Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Equity accounts usually have a credit balance. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances.

The most common contra equity account is called “treasury stock.” This special account decreases the number of shares outstanding in the market because the company repurchases some of the shares from its buyers. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.

Why would a company buy some of its stock from its buyers? The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. 

The stock that a corporation buys back is called treasury stock. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.

Once treasury stock is bought by the company, it can do either of two things concerning the fate of those shares:

1. It can retire the shares, meaning that they will no longer be existent on the company’s financial statements as treasury stock.

2. It can reissue the stock by reselling it to the public or reissue them through stock dividends or employee compensation. 

Contra revenue account

Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement.

Revenue accounts have a credit balance. To oppose the revenue made by a company, contra revenue accounts must have a debit balance. 

Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount.

The most common contra revenue accounts are:

1. Sales returns and allowances are when customers return a product they bought to get a partial or full refund.

2. Sales discounts are when the company reduces the price of a certain product whenever the customer completes the payment early.

For example, assume a company made $10,000 in sales on credit. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. A customer returned $100 worth of items, claiming them to be defective.

In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900.

Contra asset accounts journal entries

As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts.

In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet.

Let's understand this by taking an example of Accumulated Depreciation.

Supposes a car dealership purchases a car for $200,000 with the following specifications:

1. The car has no salvage value.

2. The car has a useful life of 20 years.

3. The company uses the straight-line depreciation method for the car.

This first criterion means that the car will have a net value or book value of $0 once it is fully depreciated. 

The second criterion means that the car has a useful life of 20 years. The last criterion means that the car depreciates by an equal amount each year. This means that, per year, the car will depreciate by $200,000/20 = $10,000.

In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. 

The journal entry for the depreciation expense for all twenty years will be 

The $10,000 of depreciation will reduce the book value of the car.

At the end of year 1, the car asset account of the balance sheet will record the following:

At the end of year 15, for instance, the car asset account of the balance sheet will record the following:

At the end of year 20, the car and the accumulated depreciation accounts will be written off from the balance sheet, as the car will be a fully depreciated asset.

The journal entry for the car’s removal is:

Let us take an example of Allowance for Doubtful Accounts

Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable. They are used in case some customers won’t be able to pay the money they owe to the business.

Suppose a clothing business has sold $50,000 of inventory on credit. It estimates that 2% of all receivables will not be collected. 

Therefore, the allowance for doubtful accounts should have a balance of 2%*50,000 = $1,000. The $1,000 will be recorded as a bad debt expense or uncollectible accounts expense.

The journal entry is the following:

In the balance sheet, the receivables account and its contra counterpart will appear as follows:

 

Researched and Authored by Vatche Tchelderian | LinkedIn

Free Resources

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• Accounting Period
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• Marginal Cost Formula
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