Allowance for Doubtful Accounts: Methods of Accounting for

These balances cannot offset asset accounts that do not relate to them. Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets. An asset account which is expected to have a credit balance (which is contrary to the normal debit balance of an asset account). For example, the contra asset account Allowance for Doubtful Accounts is related to Accounts Receivable. The contra asset account Accumulated Depreciation is related to a constructed asset(s), and the contra asset account Accumulated Depletion is related to natural resources.

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 contra account carries a balance that is opposite to the normal balance of its related main account. Contra asset accounts also help companies keep their general ledgers organized. By recording reductions in a separate account, companies can get better insights into their actual accounts. Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations.

  • Before we start talking about the finer details, it’s important to know what is a contra asset account.
  • Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.
  • There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue.
  • This account helps companies present a more accurate accounts receivable balance on the financial statements.
  • Machinery, physical space, equipment, vehicles, etc., are some examples of common fixed assets.
  • 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.

Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.

Why Do Accountants Use Allowance for Doubtful Accounts?

Though the Pareto Analysis can not be used on its own, it can be used to weigh accounts receivable estimates differently. For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism. Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk. In this example, the company often assigns a percentage to each classification of debt.

Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. This type of contra asset accounts is used for recording the depreciation within the timeframe of a fixed asset. 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.

The first step in accounting for the allowance for doubtful accounts is to establish the allowance. This is done by using one of the estimation methods above to predict what proportion of accounts receivable will go uncollected. For this example, let’s say a company predicts it will incur $500,000 of uncollected accounts receivable.

Example of a contra account

Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance. Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.

Contra Asset

This requirement also comes from the accounting standard for inventories. Allowance for receivables is an account that companies maintain to record possible bad debts. However, this account does not represent actual irrecoverable debts. However, a contra-asset account usually has a credit or nil balance. This account offsets the balance in the respective asset account that they pair with on the balance sheet. 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 liability accounts

This will repeat until the machinery has been totally depreciated, sold, or retired. Contra asset accounts are reported with the related account on the same financial 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. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.

Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. 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 is often referred to as the carrying amount or perhaps the net realizable amount. Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit

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. Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the financial risk analytics and modeling 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. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find.

Contra Account

The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers. 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.

Contra asset accounts are, as the name implies, accounts that are contrary to popular belief. 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. In response, the firm should decrease its accounts receivable and revenue balances.

Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950. The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance.

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