Contra assets have a natural credit balance and are used to reduce asset accounts such as accumulated depreciation. Two common examples are the allowance for doubtful accounts and accumulated depreciation. Contra accounts may have a zero balance in some cases and may require a separate disclosure paragraph.
A contra asset is an account that has a natural credit balance even though most assets have a normal debit balance. Assets represent items that a company owns and uses during business operations, such as cash, inventory, and prepaid expenses along with buildings, vehicles, and land. In the accounting equation – assets equal liabilities plus owners’ equity – the above items are all debits that increase the asset side of the equation. The contra asset still resides on the asset side of the equation, just with a credit balance. The purpose of a contra account is to reduce an asset account, such as accumulated depreciation, by reducing a construction asset account.
In financial accounting, a contra asset account is always related to an asset account. Two of the most common examples of a contra account are the allowance for doubtful accounts and accumulated depreciation. In most cases, these accounts will not show up on a balance sheet, which is the financial statement that contains all asset accounts. The contra account is connected together with the amount of the related account to reduce your balance. The net difference between the asset account and the contra account is the total shown on the balance sheet for a given period.
Companies may use a financial statement disclosure to identify and describe the use of a contra asset account. For example, the allowance for doubtful accounts indicates money owed to customers that a business does not expect to receive. There can be multiple reasons why the company does not expect to receive this money owed. Most financial disclosures state the amount expected to be lost, how the company obtained the figure, and any financial impact this lost capital will have on the business. A separate disclosure paragraph is often required for each contra account.
Contra accounts may have a zero balance in some cases, although actual instances of this may be rare. The allowance for doubtful accounts, for example, is zero if the company collects all open accounts receivable from its customers or the allowance amounts are written off as a bad debt expense. Accumulated depreciation against accounts has a balance as long as the business owns the related asset. When a business sells the asset, typically a long-term asset such as a building or a vehicle, the closing entry removes the related accumulated depreciation in the contra asset account. Therefore, these accounts will not have a balance to offset against an asset account or report through disclosures.
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