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Contra Asset is a term used in business to describe an asset that is used to offset another asset on the balance sheet. Contra assets are used to reduce the value of an asset, such as accounts receivable or inventory, that will eventually be sold or otherwise converted into cash. Most companies have contra assets on their balance sheets, though the specific items included will vary from company to company.
Definition of Contra Asset
A contra asset account is an account that is used to decrease the value of an account that is related to it. Using a contra account can help decrease or write down the historical value of an account while still preserving its value. This will create a net value that matches the current book value.
Contra accounts are displayed on the same financial statement as the account they are related to. This is usually done by putting the contra account directly below the main account on the statement, with a third line for the net amount.
How does contra asset work?
For businesses, the most common type of contra asset is the allowance for doubtful accounts, which is used to offset accounts receivable on the balance sheet. When a customer owes a business some money, the business records an account receivable.
However, there is always a chance that the customer will not pay, in which case the account receivable becomes an uncollectible debt. The allowance for doubtful accounts is used to estimate the number of uncollectible debts, and by reducing the value of accounts receivable by this amount, the balance sheet more accurately reflects the true value of the business’s assets.
Contra assets are important because they help businesses keep their balance sheets accurate by reducing the value of assets that may not be collected. This gives investors and creditors a better idea of the true financial condition of a company.
Different types of contra asset
There are mainly three types of contra assets which are:
- Allowance for doubtful accounts
Allowance for doubtful accounts is an estimate of the amount of an asset, such as accounts receivable, that will not be collected. The contra asset account is used to reduce the value of the asset on the balance sheet.
- Accumulated depreciation
Accumulated depreciation is the contra asset account used to reduce the value of a fixed asset, such as a building or machinery, over its estimated useful life. The accumulated depreciation account is used to record the amount of depreciation expense that has been charged against the asset.
- Reserve for obsolete inventory
Lastly, the reserve for obsolete inventory is the contra asset account used to reduce the value of inventory that is no longer usable. The reserve for obsolete inventory account is used to record the amount of inventory that has been written off as uncollectible.
There are also other types of contra assets, which are
- Trade accounts receivable
- Discount on notes receivable
- Accumulated depletion
Each of these has a unique purpose, but all are used to reduce the value of an asset on the balance sheet.
Conclusion
Contra asset is a tool that business uses to manage their balance sheet more accurately. Businesses need to have contra assets because it gives investors and creditors a better idea of the company’s financial condition. There are different types of contra assets, each with its purpose. When used correctly, contra assets can help businesses keep their balance sheets accurate and up-to-date.
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