Contra Asset Examples, How a Contra Asset Account Works

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. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting.

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. 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. Because of the matching principle of accounting, revenues and expenses should be recorded in the period in which they are incurred. When a sale is made on account, revenue is recorded along with account receivable. Because there is an inherent risk that clients might default on payment, accounts receivable have to be recorded at net realizable value.

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. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset.

• Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset.
• Operating expenses (OPEX) and cost of goods sold (COGS) are separate sets of expenditures incurred by businesses in running their daily operations.
• The company has to record the inventory of obsolete $ 40,000 on income statement.
• This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated.
• Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc.
• The inventory net balance will reduce by $ 40,000 as the allowance for inventory obsolete is the contra account of inventory.

The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. An inventory reserve is a contra asset account on a company’s balance sheet made in anticipation of inventory that will not be able to be sold. Every year, a company has an inventory that will not be able to be sold for various reasons. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete.

Contra Account

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

This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. 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. A contra your digital assets asset account is an account in the balance sheet that offsets the balance of a regular asset account. Later, when there is an identifiable reduction in the valuation of the inventory, reduce the amount of the inventory reserve with a debit, and credit the inventory asset account for the same amount.

• Write-downs are reported in the same way as write-offs, but instead of debiting an inventory write-off expense account, an inventory write-down expense account is debited.
• As such, for an asset or expense account that is naturally a debit account, the contra accounts will be in a credit position.
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• In order to create a balance between the two methods and to give a fuller picture of a company’s financial realities, the LIFO reserve account is necessary.
• This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000.

Allowance for doubtful accounts offsets a company’s accounts receivable account. Accumulated depreciation offsets a company’s real property assets, such as buildings, equipment and machinery. A contra account offsets the balance in another, related account with which it is paired.

Example #1: Revenue Contra Account

And when your business still has some of these outdated, unwanted, or unusable items in your inventory, you’ll want to offset the lost value of these assets in your general ledger and balance sheet. So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory. The Notes Receivable account documents the total value of any promissory notes held by the company. To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value. A contra revenue represents any deductions or offsets that need to be removed from gross revenue to provide a clearer understanding of actual income  —  such as in the example just provided. These accounts will typically help track sales discounts, product returns, and allowances (e.g., a price reduction for a good with minor defects).

Definition of Contra Account

Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. If the LIFO reserve account balance goes up or down, additional costs are then added on to the costs of the goods the company has sold throughout the year. This information is integral for investors because it enables them to see how inflation affects the value of the company’s inventory, or it allows them to determine the taxation benefits of using the LIFO or FIFO accounting methods. In this example, the contra inventory account (Allowance for Obsolete Inventory) is used to provide a more accurate and detailed representation of the company’s inventory position. By accounting for obsolescence and other adjustments, TechShop can track its actual inventory value more effectively and make more informed decisions about its inventory management and purchasing strategies. Let’s consider a fictional example of a small electronics retail business called “TechShop” to illustrate the use of a contra inventory account in financial accounting.

What is a LIFO Reserve?

To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts). 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.

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. 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. 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.

A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. An inventory write-off is an accounting term for the formal recognition of a portion of a company’s inventory that no longer has value. It may be expensed directly to the cost of goods sold (COGS) account, or it may offset the inventory asset account in a contra asset account, commonly referred to as the allowance for obsolete inventory or inventory reserve. Contra revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances.