Contra Asset Account (Definition, List) | Examples with Accounting Entry

What is Contra Asset Account?

Contra asset account is an asset account having credit balance which is related to one of the assets with debit balance and when we add the balances of two of these assets together, it will show us the net book value or carrying value of the assets having the debit balance.

List of Components of Contra Asset Account

#1 – Assets

It is prepared when there is a reduction in the value of assets due to wear and tear, continuous use or when we expect that a certain percentage of accounts receivable will not be received. Fixed assets like plant & equipment are depreciated every year and this balance is transferred to accumulated depreciation account. So, in this case, accumulated depreciation is a contra asset account related to plant & equipment.

#2 – Reduction in Value

We know that assets have debit balances however the contra assets account has credit balances. It means that this account shows the balance which is actually a reduction in the value of assets. Let’s say we expect 2% of our total receivable of $100,000 has gone bad and so we show $2,000 ($100,000*2%) as provision for doubtful debts which is actually a reduction from debtors value and means that only $98,000 is expected to be received from debtors.

#3 – Prudence

It is only prudent to show the reduction or reserve in a separate account and at any point, it gives us the netbook value explaining what the actual cost was and how much of that has been depreciated. It also helps in creating reserves and later any change in the expected number can be adjusted through allowances and reserves.

#4 – Accumulated Depreciation

Whenever an organization buys an asset and depreciated it over the useful economic life of the asset, the reduction in value every over accumulates over the year which is called accumulated depreciation. We get the remaining value of assets by deducting the accumulated depreciation balances from the book value of an asset. The accumulated depreciation balance cannot exceed the book value of the asset.

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#5 – Allowances for Doubtful Debts

When good is sold on credit, the amount receivable from customers is shown under the debtor’s balance in the balance sheet. It is normal business practice to prepare an estimate for the amount which is likely to go bad. This amount is shown as provision or reserve for doubtful debts. The provision for doubtful debts is a contra asset account which is related to debtors.

#6 – Others

Provision for a discount from creditors and discount on bills receivable are other examples which are widely used.

Example of Contra Asset Account

Let us understand how the accounting entry is posted for the contra asset account and how it is shown in the books. Let us consider that ABC Ltd. recently bought machinery for $100,000 and it plans to depreciate the machinery over a span of 5 years by using the straight-line method. In this case, the depreciation each year for this machinery will be $100,000/5 = $20,000.

Accounting Entry

By the end of the first-year machinery, balance will be $100,000 and accumulated depreciation will show $20,000. By the end of 2nd-year, the machinery balance will still be $100,000 and accumulated depreciation will show $40,000. The netbook value of the machinery by the end of the first year will be $80,000 ($100,000-$20,000) and $60,000 ($100,000-$40,000) by the end of the second year. This method helps a third person in identifying what the book value was at the time of purchase and what is the remaining value of an asset. If we just show $60,000 as an asset in the third year, it will be difficult to understand whether $60,000 is all new purchases or the remaining value of an asset. This account helps all the stakeholders in understanding the financial numbers accurately.

Advantages

Some of the advantages are a follows:

It helps in quick calculation of net book value.
The annual reports are prepared for various parties, some of them might not be accounting versed, they help them in identifying the reduction in total value.
It helps in audit facilitation and annual filings.
It is a globally accepted policy.

Disadvantages

Some of the disadvantages are a follows:

It is a time-consuming process.
Many organizations find it difficult to implement.
Need a robust accounting system, else operational difficulties may arise.

Points to Note

Nowadays with the development of a computerized accounting system, it is easy and quick to prepare the contra asset accounts as all the calculations are done by the system and hardly anything is pushed manually. However, an accountant or person in charge must ensure that any change in the value of the assets due to revaluation or impairment must be taken into consideration, accordingly, the value of the contra asset account will change. Also, with IFRS (International Financial Reporting Standards) asking to report it in a particular way, the accountants must be updated with recent changes as to how the contra assets account should appear in the books of accounts.

Conclusion

With increasing globalization and companies operating in many countries, it is imperative that the books of accounts are compatible with a global platform. They are also the result of globally accepted accounting principles for accurate reporting of financial numbers. As we have seen in the above discussion how reporting contra assets account helps in a better understanding of financial statements of any organization. So, an organization looking for a robust accounting process must move to this type of reporting for better understanding.