Define Contra Asset Account
A contra account is displayed alongside an associated account, and it has a balance that is opposite to the account it is associated with. A contra asset account is an asset account with a normal credit balance, and it will decrease an asset account. There are two main contra asset accounts you should know:
- Accumulated Depreciation: an asset type of contra account that reduces a tangible asset (building, property, equipment) to reflect an asset’s wear and tear. Depreciation is a gradual transfer of certain asset costs into an expense. Each asset will have its depreciation account. It will show the amount the asset has lost in value since its purchase. The net balance of these two accounts will show the book value of the fixed asset.
- Allowance for Bad Debt (Doubtful Accounts): another contra account that reduced the accounts receivable value in the Balance Sheet. It reflects an estimated amount a company believes it will not be able to get from its customers. The net balance of this account and the Accounts Receivable account will reflect only the amount the company expects to receive from customers.
Contra Asset Account Examples
Allowance for Doubtful Accounts
Let’s review an example. A company has an Accounts Receivable total of $27,500. It estimates the Allowance for Doubtful Accounts to be $6,400. The journal entry for this would appear as follows:
If the company is confident that they will not receive this money, they can write off an account. In this case, the company will debit Allowance for Doubtful Accounts and credit the corresponding receivables account.
The contra account amount is subtracted from the total Accounts Receivable to get a Net Accounts Receivable of $21,100, which is the net realizable receivables. An excerpt from the balance sheet would look like this:
Individuals reading the financial statements will be able to tell what the real financial picture of this particular company looks like. Otherwise, the amount under the Accounts Receivable will be misleading. Companies must estimate the allowance for bad debt correctly because otherwise, expected future cash will not be correct.
Accumulated depreciation also often appears on the company’s balance sheet. Let’s assume that a company purchases a building for $550,000. Every year, the company depreciates the building by $64,000. After three years, the net value (book value) of the building will equal $360,667 ($550,000 -$189,333). Depreciation journal entries would look as follows: