Understanding Contra Asset Accounts
Not all financial accounts function additively with one another on the balance sheet. In some instances, an account may work to counterbalance the impact of another similar account. The alleged contra accounts apply this working mechanism against other accounts. Contra implies against. Thus, a contra asset account is often paired together with an asset account and serves to reduce the balance of the asset account.
A contra asset account can be thought of as a negative account because it always has a zero or negative balance while assets accounts have a debit balance. Counterbalancing the asset account with its corresponding contra asset account depicts the net balance of the given asset. The objective of a contra asset account is to stockpile a reserve that trims down the balance in the paired account. By providing this information independently in a contra asset account, users of financial data can figure out the extent to which the paired asset ought to be cut down.
What are some of the examples of common asset accounts?
- Accumulated depreciation
- Allowance for doubtful accounts
- Inventory reserve
An accumulated depreciation account records the extent of depreciation or decline thus far on any fixed asset. Fixed assets comprise of machinery, building structures, furniture, office equipment, vehicles and so on. This account is typically a credit balance and is employed to offset against the account of the fixed asset which is generally a debit. Thus, the net balance of these two accounts, namely fixed asset account and accumulated depreciation account, reveals the net book value of the given asset.
For instance, a crane having a price tag of $60,000 and accumulated depreciation of $ 40,000 will record a book value of $ 20,000. By using both accounts, information regarding the initial price of the fixed asset can be reported on the fixed asset account, while the particulars of the depreciation or reduction of the asset will be reported on the accumulated depreciation account.
Allowance for Doubtful Accounts
The grim reality is that not all customers will pay what they owe you. An allowance for doubtful accounts normally lowers your accounts receivables. The purpose of creating this account is to factor in the scenario where some customers fail to pay you the cash they owe. When customers fail to pay the cash owed, there’s an increase in your bad debt costs account.
Bad debt is officially written off. It is money you assumed you would get but ended up getting nothing. Therefore, it hurts your overall bottom line. In contrast to bad debt, doubtful debt is not officially written off. This, instead, is money you anticipate will become bad debt, but there’s a likelihood that you may collect the money.
When you provide credit services to your customers, you must create an ADA account. Unpaid monies turn into bad debts. ADA accounting helps you predict the amount of accounts receivables that your clients won’t pay in order to foresee the losses you will suffer due to bad debt.
If you do maintain a business inventory, you know quite well that not all inventories will end up being sold and produce revenue. Several reasons are to blame including obsolete technology, perishable goods, and lack of product demand. Therefore, you can hire an accounting service in singapore and create an inventory reserve to capture this reality. Basically, an inventory reserve predicts inventory losses and sets aside an allowance in expectation of inventory loss.
Say an organisation has inventory worth $300, 000 and anticipates that 2 per cent of inventory will go bad. On the balance sheet, the accountant will record the gross inventory as an asset valued at $300, 000. He or she will then create a negative balance of $6,000 (2 per cent of $300,000) in the inventory reserve. Therefore, the organisation will claim a net inventory worth $294, 000 ($300, 000 minus $6,000). Ultimately, the organisation will account for the inventory reserve by listing a $6, 000 outgoings on its income statement.
Hire accounting services in Singapore who can employ the use of contra asset accounts to probe asset reductions independently from the said asset. In the end, the balance sheet summary reveals the initial value of the asset, the extent to which the asset has depreciated and the net value of that asset.