Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory.

Examples of 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. The difference between an asset’s account balance and the contra account balance is known as the book value. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Accounting software can simplify the management of and reporting from your ledger. With the appropriate level of automation integration in your chosen tool, you can pull the relevant values into these individual accounts directly from invoices, credit agreements, and other documentation.

Types of contra accounts

Therefore, contra-asset accounts differ from other accounts that have a credit balance. Inventory obsolescence is an expense account, while the allowance for obsolete inventory is a contra asset account, which aims to reduce the inventory valuation on your balance sheet. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset.

Definition and Examples of Contra Assets

• This depreciation is saved in a contra asset account called accumulated depreciation.
• Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory.
• By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount.
• The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment.
• A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger.
• A separate account is needed whenever the nature of transactions changes.

Contra accounts help provide more accurate financial information by separating certain items and highlighting their impact on the overall financial position. A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines. For its day-to-day operations, the business maintains a fleet of 75 identical 2016 Ford Explorer limousines, each initially retailing at $150 thousand. However, these vehicles have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand. For industries that rely on natural resources — mining, logging, oil, gas — depletion tracks the gradual exhaustion of the raw material in question, offsetting that loss in value against the initial appraisal of the land.

• If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete.
• Examples of a contra revenue accounts include sales returns, sales discounts, and sales allowances.
• These include accumulated depreciation, accumulated amortization, allowance for receivables, obsolete inventory, and discount on notes receivables.
• Generally speaking, the use of contra accounts is to ensure their related accounts stay clean and to keep track of historical cost easier.
• The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.

What Is the Benefit of Using a Contra Account?

To convert your invoice management efforts to an electronic format that can easily share data with other financial systems, businesses can leverage Invoiced’s E-invoice Network. At the same time, our Accounts Receivable Automation software and Accounts Payable Automation software makes tracking, managing, and processing crucial assets and liabilities — and their contras — easier than ever before. A contra account carries a balance that is opposite to the normal balance of its related main account. As mentioned, companies do not represent these accounts on the balance sheet. However, they will still appear on the notes to the financial statements with necessary disclosures.

• You may want to first classify contra accounts as contra asset accounts, contra liability accounts, contra equity accounts, or contra revenue accounts before accounting for any transaction.
• That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100.
• 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.
• When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000.
• Each of these contra accounts serves to provide more detailed information about the transaction history of the related main account.

How Are Contra Accounts Reported in Financial Statements?

When the contra account reads $500 and the normal credit balance is $100,000, then your net sales are $99,500. This indicates that out of $100,000 sales, your customers return goods valued at $500. With contra equity accounts, you reduce the number of outstanding shares you list on your company’s balance sheet. Treasury stock and owner’s drawing account are examples of contra equity accounts.

Contra revenue accounts typically offset revenue accounts in a firm’s income statement. 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.

Revenue Contra Account

To compensate for those potential deadbeat customers, you can use a Bad Debts account to serve as a contra for your A/R. Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing. If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $10 thousand in discounts during that same timeframe.

• The difference between an asset’s account balance and the contra account balance is known as the book value.
• This will ensure the net value of accounts receivable at year-end is not overstated.
• Note that in accounting, the term “book value” is also used interchangeably with net value.
• In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account.
• 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).

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). The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s balance sheet. contra account For liability and revenue accounts, credit transactions will increase and debit transactions will decrease the account balances. Sometimes, we have an ancillary balance whose normal balance is the same as that of the parent account. For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances.

For example, accumulated depreciation will go along with related assets. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance. Both of these accounts offset each other to represent a net balance on a company’s balance sheet. If the bond is sold at a discount, the company will record the cash received from the bond sale as “cash”, and will offset the discount in the contra liability account. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.