How to Use Contra Asset Accounts

Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value.

Understanding contra accounts

• 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.
• A company uses this account to record how many accounts receivable it thinks will be lost.
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• In order to keep the accounts receivables as clean as possible with their historical values, we will use this contra account called allowance for doubtful accounts.

Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account. This requirement also comes from the http://ru-egypt.com/sources/221/ accounting standard for inventories. Management may disclose its method of estimating the allowance for doubtful accounts in its notes to the financial statements.

Allowance for Doubtful Accounts

The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming.

Financial Controller: Overview, Qualification, Role, and Responsibilities

The sales method applies a flat percentage to the total dollar amount of sales for the period. For example, based on previous experience, a company may expect that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid.

Single Entry vs Double Entry Bookkeeping and Accounting

The company must record an additional expense for this amount to also increase the allowance’s credit balance. Assume a company has 100 clients and believes there are 11 accounts https://www.fastdrive.org/2019/04/ that may go uncollected. Instead of applying percentages or weights, it may simply aggregate the account balance for all 11 customers and use that figure as the allowance amount.

Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. As mentioned, there can be a contra account for any type of transaction depending on a company’s needs. Other than the above contra-asset accounts, we often see contra-revenue accounts for any sales returns or sales rebates.

• Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.
• Each account in a general ledger will be designated debit or credit accounts depending on whether they’re categorized as assets, liabilities, revenues or expenses.
• For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life.
• For example, a bond with a principal amount of $1,000 may be sold for only $950.
• The company must record an additional expense for this amount to also increase the allowance’s credit balance.

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. Using the allowance for doubtful accounts, the https://www.heydudeshopping.com/how-to-choose-the-right-belt-size/ will more accurately reflect your true accounts receivable balance and make sure sure that your financial statements reflect the most accurate information possible. If you’re still using manual accounting systems, you’ll need to do a bit more work by recording your accumulated depreciation expense in your general ledger while also reporting it on your balance sheet as a contra asset account. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.