A contra asset account, such as accumulated depreciation, reduces the balance of an asset. For example, a company may record accumulated depreciation to account for the wear and tear on its machinery or vehicles. 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.

However, they will still appear on the notes to the financial statements with necessary disclosures. The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory. Contra asset accounts provide business owners with the true value of certain asset accounts. For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset.

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This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable 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. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.

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. In reality, the actual number of company discounts came closer to $5 thousand. Rather, it is an adjunct account or a valuation account that is added to the face value of the bonds to arrive at the carrying value (or book value) of the bonds on the balance sheet.

Fiduciary Meaning in Accounting, Types, and Examples

By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.

The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Recording a contra account involves offsetting the value of one account by using another account. When it comes to contra asset accounts, the offset is made to an expense account, like bad debt expense. This allows companies to estimate a reasonable amount to book into the contra account using the allowance method of accounting or the percentage of sales method. Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. If the company repays the loan early, the lender may provide a discount.

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When the amount recorded in the contra revenue accounts is subtracted from the amount of gross revenue, it equals the net revenue of a company. In case a customer returns a product, the company will record the financial activity under the sales return account. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced. In the event that a contra account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult.

Each type of contra account has its specific purpose in financial reporting, helping to present a more accurate and detailed picture of a company’s financial position. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. In other words, contra revenue is a deduction from gross revenue, which results in net revenue.

Types of Contra Accounts

Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts. In other words, contra accounts are used to reduce normal accounts on the balance sheet. By understanding the nature and function contra asset account examples of contra accounts, businesses can accurately reflect their financial position, providing transparency to stakeholders such as investors, creditors, and internal management. As mentioned, companies do not represent these accounts on the balance sheet.