A Beginner’s Guide to Using Contra Asset Accounts

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Contra accounts are those paired with a related account and used to track and offset the value of the account they’re associated with. For example, if your account normally has a debit balance, the contra account associated with it would have a normal credit balance.

If they’re associated with an asset account, contra accounts will always have a credit balance, but if they’re associated with an account that normally carries a credit balance, a contra account will have a debit balance.

Contra asset accounts will always carry a credit balance since the accounts they are associated with have a debit balance. We’ll explain in this article what a contra asset account is and how to properly use them.


Overview: What is a contra asset account?

In accounting, assets are things of value that your business owns. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts.

Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance.

Contra asset accounts are used in relation to a standard asset account and are designed to offset the balance of the account that they’re associated with. Unlike regular asset accounts, which always have a debit balance, contra asset accounts will have a credit balance.

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For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date.

If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.

If you’re still using manual accounting systems, you’ll need to do a bit more work by recording your accumulated depreciation expense in your general ledger while also reporting it on your balance sheet as a contra asset account.

A graphic displaying the components of contra asset accounts in a circular fashion.

Contra asset accounts start with assets and are used to reduce the value of their associated asset account. Source: wallstreetmojo.com.

Why are contra asset accounts important for businesses?

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.

Using the allowance for doubtful accounts, the contra asset account will more accurately reflect your true accounts receivable balance and make sure sure that your financial statements reflect the most accurate information possible.


3 types of contra asset accounts

Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to.

1. Accumulated depreciation

The accumulated depreciation account is perhaps the most common contra asset account used by business owners.

Anytime you need to depreciate an asset, you’ll use an accumulated depreciation contra asset account, which records the amount of depreciation that has been expensed while offsetting the value of the asset being depreciated.

This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated.

2. Obsolete inventory

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.

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If you end up with $3,000 worth of obsolete inventory, you would make the following journal entry:

Date

Account

Debit

Credit

7-73-2020

Inventory obsolescence

$3,000

7-31-2020

Allowance for obsolete inventory

$3,000

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.

Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account.

3. Allowance for doubtful accounts

If you offer credit terms to your customers, you probably know that not all of them will pay. That’s where the allowance for doubtful accounts comes in. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance.

You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount.


An example of recording a contra asset

The purpose of a contra asset account is to reduce the value of the asset account it’s associated with. For example, if you purchase a piece of machinery for your business in August, you’ll be depreciating that machinery starting in September. The journal entry after purchasing the machinery would be:

Date

Account

Debit

Credit

8-1-2020

Machinery

$8,000

8-1-2020

Cash

$8,000

You’ll also need to create a contra asset account to track the depreciation expense that will be recorded starting in September. This contra asset account will also offset the current value of the machinery. When you start to depreciate the machinery in September, this would be the entry:

Date

Account

Debit

Credit

9-1-2020

Depreciation Expense

$133.33

9-1-2020

Accumulated Depreciation

$133.33


Frequently asked questions for contra asset accounts

Do contra asset accounts always have a credit balance?

Yes. They should have a credit balance or a zero balance, depending on whether they’re still being used. For example, when you’re through depreciating an asset, the contra asset account for accumulated depreciation will have a zero balance.

Do I have to use a contra asset account for my receivables?

You don’t have to, yet even a small business will benefit by using the contra asset account for accounts receivable. This eliminates the need to write off large accounts receivable balances at year end since they’ve already been accounted for.

If I stock inventory, should I use the allowance for obsolete inventory contra asset account?

It really depends on what you’re selling. If you stock a limited amount of inventory, you could probably do without it.

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.


A final word about contra asset accounts

You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity.

While tracking contra asset accounts is cumbersome for bookkeepers and accounting clerks using manual accounting systems, if you’re using accounting software you’ll find that most of the heavy lifting is done for you.

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.

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View more information: https://www.fool.com/the-blueprint/contra-asset-account/

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