Allowance For Doubtful Accounts And Bad Debt Expenses

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. The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits.

The contra asset account can also be combined with a current inventory account, allowing a financial analyst to determine the current market value of the company’s inventory. Now, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. Contra revenue is a deduction from the gross revenue reported by a business, which results in net revenue. Contra revenue transactions are recorded in one or more contra revenue accounts, which usually have a debit balance . Allowance for doubtful accounts is a common contra asset listed on a company’s balance sheet under accounts receivable.

Therefore, an example of a payroll involved with a depreciation situation seems reasonable to observe. Nova Incorporated is attempting to finalize their balance sheet in terms of the net value of their assets. At the end of the year, their assets are as follows… Nova Company valued a van at $30,000, an office building at $500,000 and office equipment at $20,000. At the same time, depreciation for the van at the end of the year ended up at $500. When examining the term “contra asset account,” look no further than the root of contra to get a vague grasp of the definition. Because contra means “against,” one could quickly conclude that a contra asset account is going to be an account that goes against the regular asset account on the Balance Sheet. Quite frankly, the actual definition is not far from this estimate.

What Is A Contra Account?

The asset account above has been added to by a debit value X, i.e. the balance has increased by £X or $X. Likewise, in the liability account below, the X in the credit column denotes the increasing effect on the liability account balance , because a credit to a liability account is an increase.

Long-term liability, when money may be owed for more than one year. Examples include trust accounts, debenture, mortgage loans and more. To make contra entries there must be both a customer and supplier account for the company and the two accounts must operate in the same currency. 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. This discount is subtracted from the total amount borrowed to better reflect the discount given by the lender.

Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. Purchase returns, allowances and discounts are all examples of contra expense accounts. The accounts normally have a credit balance and in use are offset against the purchases account which is normally a debit balance. A contra equity account reduces the total number of outstanding shares listed on a company’s balance sheet.

Accounts payable is considered a current liability, not an asset, on the balance sheet. There are many situations where one account is used to offset another account. One common example is accumulated amortisation, which is a contra-asset account. This means that it acts in the opposite manner of a regular asset account. Purchases Charged to Your Card When you make a purchase with your card enter it like a Vendor Check, as though you were paying the vendor, but be sure to select your contra asset as the Checkbook. A company creates allowances for doubtful accounts to record the portion of accounts receivable which it believes it will no longer be able to collect. The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company.

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.

This transaction records when a customer returns the paid goods, and a refund needs to be given. It is a general ledger account with a purpose to have its balance to be the opposite of the original balance for that account. It is linked to specific accounts and is reported as reductions from these accounts. Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock. So, the company’s total value of receivables results in $95,000, and Power Manufacturers may then adjust this calculation in their financial records as they receive more credit sales. Trade accounts receivable refer to an amount that a company bills to its clients when delivering goods or services. These billings may usually be documented on invoices, which are then summarized in an aging report for all the business’s accounts receivable.

You don’t have to have a separate depreciation account; you can just post the depreciation amounts directly to the asset account. If you have a separate account, the balance will show the total depreciation taken on the asset; if you post directly the balance will show the current book value of the asset. On the other hand, if you separate them then the Balance Sheet will show the current book value in the Asset account and, if you have the depth set high enough, the total depreciation in the depreciation sub-account. You could go one step further and make the asset account itself a placeholder with a buy/sell and a depreciation sub-accounts. That way the Balance sheet will show the net in the asset account with the purchase price in the buy/sell sub-account and the total depreciation in the depreciation sub-account.

In finance and accounting, accounts payable can serve as either a credit or a debit. Because accounts payable is a liability account, it should have a credit balance. The credit balance indicates the amount that a company owes to its vendors. Cash is the asset that is recorded upon receipt of funds, and since assets must equal liabilities plus equity, the other side of the journal entry must be a liability account. That being said, unearned rent does not remain a liability forever.

What Are The Examples Of Current Assets?

Check out these alternative options for popular software solutions. Notes PayableNotes Payable is a promissory note that records the borrower’s written promise to the lender for paying up a certain amount, with interest, by a specified date. BondsA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually. Contains either an allowance for reductions in the price of a product that has minor defects, or the actual amount of the allowance attributable to specific sales. Contains either an allowance for returned goods, or the actual amount of revenue deduction attributable to returned goods.

• When reporting a contra account in a company’s financial statement, it is reported immediately below the account it relates to or corresponds.
• 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.
• The contra liability account is less common than the contra asset account.
• If the related account has a debit as the natural balance, then the contra account will record a credit.

In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet. More specifically, record the contra asset as a credit that is supposed to balance out a correlating plant asset.

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Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. The two common contra liability accounts, discount on bonds payable and discount on notes payable, carry normal debit balances. The discount on bonds payable represents the difference between the amount of cash a company receives when issuing a bond and the value of the bond at maturity. Notes payable represents a liability created when a company signs a written agreement to borrow a specific amount of money.

To record the purchase of a fixed asset, debit the asset account for the purchase price, and credit the cash account for the same amount. For example, a temporary staffing agency purchased $3,000 worth of furniture. A contra expense account is a general ledger expense account that is expected to have a credit balance instead of the usual debit balance. In other words, the account’s credit balance is contrary to the usual debit balance for an expense account. The balance owed on a credit card can be treated either as a liability or a negative asset, known as a “contra” asset. Whether you make payments over time or pay the balance in full each month there are several advantages to using the contra asset approach.

The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. Normal balance is the side where the balance of the account is normally found. Current assets are located in the beginning of the assets section of the balance sheet. This part of the balance sheet contains those assets most easily convertible into cash in the short-term.

How Should Investors Interpret Accounts Receivable Information On A Company’s Balance Sheet?

These accounts can be listed based on the respective asset, liability, or equity account to reduce their original balance. The totals show the net effect on the accounting equation and the double-entry principle, where the transactions are balanced. 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. Contra revenue account, which is used to record the net amounts and usually has a debit balance, as opposed to the revenue account that records the gross amounts. If you are not using the reconciliation feature to record finance charges and fees then include a second GL Account number for your credit card fees expense account. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account. Long-Term Assets are parent accounts that contain the original acquisition cost of fixed assets.

A contra liability account is not classified as a liability, since it does not represent a future obligation. This type of account can equalize balances in the asset account that it is paired with on a business’s balance sheet.

For instance, a fixed asset such as machinery, a company building, office equipment, vehicles or even office furniture would be highlighted in an accumulated depreciation account. This amount may appear on a company’s balance sheet, and it can ultimately result in a reduction in the gross amount of a business’s fixed assets.

However, if you sell items that quickly become obsolete, such as consumable products with an expiration date or electronics that become quickly outdated, using the allowance for obsolete inventory is a must. If you stock a limited amount of inventory, you could probably do without it. If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete.

Contra Accounts Increase Transparency

The lender may offer the company a discount if it repays the note early. The discount on notes bookkeeping payable reduces the total amount of the note to reflect the discount given by the lender.

The financial leverage has credited balances that can reduce the balance in its paired asset account. A company can choose to state this information as separate line items on its balance sheet so that any financial planners or analysts can determine the extent to which a paired asset might be reduced. When a company evaluates its financial position, a financial analyst might calculate the total amounts that the company stores in its asset accounts. While financial information on these accounts might include receivables collected, the company can also choose to include its contra asset accounts as a separate line item on the balance sheet.

Now let us say that Power Manufacturers, Inc. reports its total credit sales for the quarter at $100,000, and it additionally estimates that 5% of all the credit sales made in the past quarter will default on payment. On the balance sheet, the allowance for doubtful accounts can reduce the totals in the business’s accounts receivable.

Contra Equity Account

An example would be a contra liability account which would be debited to offset a regular liability account. A contra account is used in order to better portray the relationship between certain debits and credits within the overall financial structure of an entity. A contra account can be used to remedy an error, to track depreciation of an asset, or to register payments that are not collectible. The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible. The balance sheet shows the amount in the asset section underneath the accounts receivable.

Author: David Ringstrom