Contra Asset Accounts
For a company, an asset
could be defined as a resource it owns having an economic value that can be expressed and measured in monetary terms. Assets benefit the firm's operation and help to increase its profitability.
Examples of asset types are cash, cash equivalents, equipment, buildings, land, supplies, inventory, and account receivable, etc.
Asset and Contra Asset Accounts
ASSET ACCOUNTS are presented on the left side of the balance sheet, indicating debit, having a natural positive account balance.
A CONTRA ASSET ACCOUNT is a type of asset account that offsets the balance of its associated paired asset account. For instance, depreciation is the contra asset account of equipment and building. Contra asset accounts natural balance always maintains a zero or negative balance, contrary to its paired asset account. The term "contra" is used in relation to its associated normal asset account with debit natural balance because the contra asset account maintains a credit balance.
Balancing Asset Accounts and Contra Asset Accounts
When we add the normal balances of these two asset accounts together, it will present the carrying or the net book value
of the asset.
Types of Contra Asset Accounts
There are three main types of the contra asset account.
- Accumulated depreciation. This is a common contra asset account that offsets and records the depreciation amount of its associated fixed asset account. Accumulated depreciation credit balance and fixed asset debit balance allow us to see the remaining net book value of the fixed asset.
Example: Assume that ABC company purchases a piece of equipment costing €50,000 with the estimated useful life of five years and applies straight-line depreciation method. So, the journal entry for recording the purchase of equipment would be:
In order to track the associated depreciation expense of the purchased equipment, there is a need to create a contra asset account to offset the current value of the equipment. Thus, accumulated depreciation, the contra asset account, will be credited by €10,000 each year to record the depreciated amount and at the end of the year, the journal entry would be:.
So, the net book value of the equipment at the end of the first year would be €40,000 (€50,000-€10,000). At the end of the fifth year, the net book value of the equipment would be €0 (€50,000-(5*€10,000)).
- Allowance for bad debt. This is another contra asset account that offsets and reduces the amount of account receivable against credit sales. When a company made credit sales, there is a probability that the credit customer may not pay all the owed money. Thus, there is a need to create an allowance for bad debt account, contra asset account, to safeguard the account receivable balance from overstating.
Example: Assume that ABC company made a credit sale of €50,000 and estimated that 5% of all previous credit sales will default on payment. The allowance for bad debt account will reduce the account receivable balance on the balance sheet. So, at the end of the year, the account receivable balance will be reduced by the estimated 5% default rate. The entry would be:
Thus, on the balance sheet, the net account receivable balance would be €47,500 (€50,000- €2,500).
- Reserve for obsolete inventory. Specifically in manufacturing companies, bulk inventory stocks are manufactured and kept in the warehouses to offset the need of their products. As a result, some inventory will become obsolete when it is expired or become outdated. Thus, to reduce or offset the obsolete inventory on the balance sheet, a contra asset account of allowance for obsolete inventory is created.
Example: Assume that ABC company analyzed an obsolete inventory of €1,500 from its inventory stock. The journal entry for recording this obsolete inventory through contra asset account would be:
Stuart A. McCrary (2010), "Mastering Financial Accounting Essentials: The Critical Nuts and Bolts".
Mery Grisch Bock (2020), "How to Use contra asset account".