Online Accounting

Online Accounting

accounts receivable contra account

When it comes to your small business, you don’t want to be in the dark. Your accounting books should reflect how much money you have at your business. If you use double-entry accounting, you also record the amount of money customers owe you. To protect your business, you can create an allowance for doubtful accounts. This, of course, changes if an asset is sold because the accumulated depreciation account must be zeroed out.

This allows the company to know the amount uncollected from each customer. Such information can be used in the future to try and collect on outstanding debt. Companies can use their accounts receivable as collateral when obtaining a loan (asset-based lending).

The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. The income statement account Sales Returns and Allowances is a contra revenue account that is associated with the revenue account Sales. If the balance in this contra account is a debit of $3,000 and the Sales account has the expected credit balance of $400,000, the company’s net sales are $397,000. This use of Sales Returns and Allowances enables management to see that its customers had a problem with $3,000 of the company’s goods. For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances.

Reasons To Include Contra Asset Accounts On A Balance Sheet

For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset. The adjustment to long-term debt, on the other hand, is a contra liability account to mortgage payable that reduces the mortgage payable for long-term debt only. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts. Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue. Contra RevenueContra revenue refers to any difference between a company’s gross sales and net sales due to sales returns, allowances or discount. Accumulated depreciation accounts are asset accounts with a credit balance .

accounts receivable contra account

Eying the Trial Balance When reviewing the trial balance for errors, the first step is to eye the accounts to see that each account’s balance is in the proper debit or credit column. The account is an income account that is expected to hold a balance opposite to what is normally expected, to counteract the balance in another income account. Accumulated Depreciation, used to diminish the value of an asset over time, is another example of a contra-account. When a company has both receivables and payables to the same business or individual, the value of one or the other is reduced. In a default situation, the amounts are offset, and the receivable value is lower or nonexistent. In some cases, you may write off the money a customer owed you in your books only for them to come back and pay you. If a customer ends up paying (e.g., a collection agency collects their payment) and you have already written off the money they owed, you need to reverse the account.

Whenever a balance sheet is to be produced, these two accounts are netted to arrive at net realizable value, the figure to be reported for this asset. An accounts receivable T-account monitors the total due from all of a company’s customers.

As explained by Investopedia, a contra account is a type of general ledger account that’s used specifically for the purpose of reducing an associated account’s balance. In a contra account, however, the balance is positive — and this is the characteristic feature of contra accounts. They have a credit balance instead of a debit balance, allowing them to reduce the paired account’s total balance.

Understanding Contra Accounts

To create a standard allowance, have those financial records that indicate how many accounts have not been collected. Then create an average amount of money lost over the number of years measured. Once done, a company can compare these to the records of other companies or industry statistics. The company can use this information to attempt to bring this amount to an equal level, as compared to common industry best practices.

accounts receivable contra account

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. Of course, these two main accounts have a number of different subsets. For example, a contra asset account used in conjunction with accounts receivable is called an allowance for doubtful accounts or bad debt reserve. In this case, the contra account might represent outstanding customer debts that you probably won’t be able to collect.

Using a contra account, you can record nonpayments so they don’t adversely affect your accounts receivables. Similarly, the account listed with the main liability account is called a contra liability account.

Of course, if a client has filed for bankruptcy, any amounts owed will likely have to go into uncollectible status. Keep in mind that allowance Online Accounting for Doubtful Accounts is often an estimate. Knowing a business is high risk can help in building a more robust debt collection policy.

A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. 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.

Types Of Contra Asset Accounts

A normal asset has a debit balance, while a contra asset sits against this to show the net balance of both assets on your financial statement. Some basic examples of contra accounts are bad debt and depreciation. Bad debt is uncollectible revenue, which offsets a doubtful receivable.

An example of a common payment term is Net 30 days, which means that payment is due at the end of 30 days from the date of invoice. The debtor is free to pay before the due date; businesses can offer a discount accounts receivable contra account for early payment. Other common payment terms include Net 45, Net 60 and 30 days end of month. The creditor may be able to charge late fees or interest if the amount is not paid by the due date.

  • However, the process of maintaining and collecting payments on the accounts receivable is more complex.
  • For example, if a company overdraws its bank account, the Cash account will have a temporary credit balance.
  • The maturity date of a note determines whether it is placed with current assets or long-term assets on the balance sheet.
  • At the end of the first year, the net value of the equipment would be $300,000 – $50,000 in accumulated depreciation, so the net value of the equipment at the end of the first year would amount to $250,000.
  • For example, it is not very useful to show the PPE cost account and the related accumulated depreciation account separately on the balance sheet.

So the interest expense and interest payable can be listed separately to the security deposit amount owed as interest obligation on the funds deposited. The interest expense would not be reversed since it is an actual expense recorded for the period. Contains the amount of sales discount given to customers, which is usually a discount given in exchange for early payments by customers.

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Sales Allowances-Sales allowances are also a part of the sales account. Sales allowance is the reduction in contra asset account the selling price when a customer agrees to accept a defective unit instead of returning it to the seller.

A Contra Asset Account Is An Account That Subtracts From An Asset Account

Accounts receivable is an asset which is the result of accrual accounting. In this case, the firm has delivered products or rendered services , but no cash has been received, as the firm is allowing the customer to pay at a later point in time. There’s also a contra liability account, which is somewhat confusing given Online Accounting that it’s not an actual liability account. Rather, a contra liability account is used to offset a payable account. A bond discount account, for instance, is a type of contra liability account. When a bond discount account is added to a contra liability account, it reveals the carrying value of the respective bond.

When customers buy products on credit and then don’t pay their bills, the selling company must write-off the unpaid bill as uncollectible. Allowance for uncollectible accounts is also referred to as allowance for doubtful accounts, and may be expensed as bad debt expense or uncollectible accounts expense. There are multiple types of contra asset accounts that can be used to show a company’s true financial picture on a balance sheet.

What Category Is A Contra Asset Account?

In other words, contra accounts are used to reduce normal accounts on the balance sheet. Definition of Prepaid Expenses In other words, prepaid expenses are costs that have been paid but are not yet used up or have not yet expired. Generally, the amount of prepaid expenses that will be used up within one year are reported on a company’s balance sheet as a current asset. A contra asset is a negative asset account that offsets the asset account with which it is paired. The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. Accounts Receivable has a debit balance; its contra account, Allowance for Doubtful Accounts, has a credit balance.

A contra revenue account carries a debit balance and reduces the total amount of a company’s revenue. The amount of gross revenue minus the amount recorded in the contra revenue accounts equal a company’s net revenue. A transaction is made under the sales return account when a customer returns a product to the company for a refund. Sales allowance represents discounts given to customers to entice them to keep products instead of returning them, such as with slightly defective items. The sales discount account represents the discount amount a company gives to customers as an incentive to purchase its products or services. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.