The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level. The process of using debits https://www.wave-accounting.net/ and credits creates a ledger format that resembles the letter “T”. The term “T-account” is accounting jargon for a “ledger account” and is often used when discussing bookkeeping.
There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance.
What are the types of Contra Accounts?
Balance Sheet AccountsA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. Allowance for doubtful accounts is a contra asset account used to create an allowance for customers that are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
- The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline.
- Equity accounts record the claims of the owners of the business/entity to the assets of that business/entity.Capital, retained earnings, drawings, common stock, accumulated funds, etc.
- 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.
- A depositor’s bank account is actually a Liability to the bank, because the bank legally owes the money to the depositor.
All “mini-ledgers” in this section show standard increasing attributes for the five elements of accounting. Free Cash Flow The money left over after a company supports operations can be a snapshot of its financial health. Home Depot also devotes footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature. Let’s go over how they work and what the main types are, and then finish with an example.
Contra equity and contra revenue
If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it. It could be growing with bad accounts, and cash flow will be affected. So, essentially, all these situations are mistakes that people could make. The only real reason you would want to have asset accounts with a credit balance is if they were intentionally set up as a contra asset account. Before you issue a balance sheet, fix any errors and reclassified any asset accounts with a credit balance as a liability. The contra revenue account is a reduction from gross revenue, which results in net revenue.
Contra accounts relate to all areas in the balance sheet, including assets, liabilities, and equity. These accounts are crucial in the financial reporting process, as stated above. When a good is sold on credit, the amount receivable from customers is shown under the debtor’s balance sheet balance.
What is a Contra Account? Definition
In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000. 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. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense.
What does a contra account mean?
A contra account is a negative account that is netted from the balance of another account on the balance sheet. The two most common contra accounts are the allowance for doubtful accounts/bad debt reserve, which is subtracted from accounts receivable, and accumulated depreciation, which is subtracted from fixed assets.
Each transaction that takes place within the business will consist of at least one debit to a specific account and at least one credit to another specific account. A debit to one account can be balanced by more than one credit to other accounts, and vice versa. For all transactions, the total debits must be equal to the total credits and therefore balance. The allowance for doubtful accounts is not specifically reported, but the 10 reported that the allowance is immaterial to the amount. This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms.