The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Data-backed inventory replenishment decisions can reduce the amount of dead stock you have as well as inventory carrying costs. Optimally restocking inventory becomes a breeze with tech-powered inventory management solutions.

• Then, they immediately create an inventory reserve account, to which they add $1,000 and deduct the same amount as an expense.
• A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger.
• Running an online business, it’s important to keep value depreciation in mind when tracking, managing, and reporting on inventory.
• To account for this potential obsolescence, TechShop creates a contra inventory account called “Allowance for Obsolete Inventory” with a credit balance of $10,000.
• The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger.

The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense. For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. A contra liability is a general ledger account with a debit balance that reduces the normal credit balance of a standard liability account to present the net value on a balance sheet. Examples of contra liabilities are Discounts on Bonds and Notes Payable and Short-Term Portion of Long-Term Debt. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

Tips for reducing inventory impairment

To account for this potential obsolescence, TechShop creates a contra inventory account called “Allowance for Obsolete Inventory” with a credit balance of $10,000. Let’s consider a fictional example of a small electronics retail business called “TechShop” to illustrate the use of a contra inventory account in financial accounting. This method allows you to track the total size of the write-down and keep tabs on the historical cost in the original inventory account. Contra accounts are used to help a company report the original amount of a transaction as well as reductions that may have happened. They serve an invaluable function in financial reporting that enhances transparency in accounting books. The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of.

A company might decide to purchase its stock when the board of directors feel the stock is undervalued or when it wishes to pay its shareholders dividends. When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. An ending inventory balance is reported as a current asset on the balance sheet at the end of an accounting period.

What is an inventory write-down?

Similarly, accrued liabilities reduce the total amount of current liabilities. These three types of contra accounts are used to reduce liabilities, https://accounting-services.net/contra-inventory-account-accountingtools/ equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount.

Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective”), an SEC-registered investment adviser. A copy of Carbon Collective’s current written disclosure statement discussing Carbon Collective’s business operations, services, and fees is available at the SEC’s investment adviser public information website – or our legal documents here. Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. This discount is subtracted from the total amount borrowed to better reflect the discount given by the lender. The discount on bonds payable amount shows the difference between the amount of cash received when issuing a bond and the value of the bond at maturity.

Contra Revenue Account

When offset against the related inventory account, the contra account results in a lower reported level of inventory in the financial statements. The contra asset account carries a credit balance because an asset account usually has a debit balance. Such accounts are allowance for doubtful accounts and the accumulated depreciation account. Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset.

Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. A contra liability is an account in which activity is recorded as a debit balance is used to decrease the balance of a liability. It is not classified as a liability since it does not represent a future obligation. A contra inventory account is a general ledger account that is paired with the inventory account, and which contains a negative balance that represents a reserve for obsolete or damaged goods.

This can help anyone viewing the financial information to find the historical cost of the asset. The accumulated depreciation amount shows how much depreciation expense has been charged against an asset. Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet.

For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date. A contra inventory account is especially useful when market prices are lower than inventory costs, which will trigger a lower of cost or market adjustment. A third possible use for the account is when some of the inventory is no longer listed in the bills of material for current products, and so will not be used. When the inventory is disposed of, you can debit the inventory reserve and credit the inventory account. It’s worth noting that smaller write-offs can be reported as COGS, rather than a write-down.

For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.

• In this example, the contra inventory account (Allowance for Obsolete Inventory) is used to provide a more accurate and detailed representation of the company’s inventory position.
• Contra accounts serve an invaluable function in financial reporting that enhances transparency in accounting books.
• Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances.
• The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible.
• When the amount recorded in the contra revenue accounts is subtracted from the amount of gross revenue, it equals the net revenue of a company.