What is a contra inventory account?

If you’re still using manual accounting systems, you’ll need to do a bit more work by recording your accumulated depreciation expense in your general ledger while also reporting it on your balance sheet as a contra asset account. For instance, if a company has a plant asset such as Equipment with a debit balance of $92,000 and the account Accumulated Depreciation has a credit balance of $50,000, the carrying amount (or book value) of the equipment is $42,000. The obsolete inventory reserve account is the contra account to inventory, another asset listed on the balance sheet. Products that become unusable are recorded in this contra account to show that they are still owned by the company, but they should be excluded from the market value of inventory. Contra assets are negative asset accounts that show an opposite balance to a normal account in the same asset category. The purpose of a contra asset account is to offset the asset account and show a reserved amount that reduces the balance of the corresponding asset account.

• You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount.
• The company later identifies $10,000 of obsolete inventory; it writes down the value of the inventory with a $10,000 debit to the inventory reserve contra account and a credit to the inventory account.
• On the balance sheet, the net inventory value will be reported as $190,000 ($200,000 – $10,000), reflecting the impact of the allowance for obsolete inventory.
• At some point, a company will have to concede that they have inventory that can’t be sold.
• Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to.
• The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.

By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset. The difference between the gross balance of a main account and its contra accounts reported as the net balance in a company’s financial statements is also referred to as a book value, current value, carrying value, or net realizable value. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately.

Contra assets

Contra assets are an important bookkeeping concept that helps balance a business’s books. In this article, we look closely at contra assets and the different types of contra accounts you may see on financial statements. 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. When offset against the related inventory account, the contra account results in a lower reported level of inventory in the financial statements. Properly documenting these contra accounts in your ledger can sometimes feel counter-intuitive since they operate in an opposite manner from their parent accounts. Consider an asset account, where the values are listed as debits, and the account itself will present a positive total.

Once inventory that is unable to be sold is actually identified it is written down in official recognition of the loss. Rather than pay this cost up-front and tie up a significant chunk of capital, Show-Fleur makes this purchase on credit with a 90-day due date after invoicing. Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings. Wanting to spruce up its aging inventory, Show-Fleur purchased new, climate controlled-seats for its fleet, delivering increased comfort for passengers and a cleaner, more modern look for vehicle interiors.

The Contra Asset Account

Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. https://accounting-services.net/understanding-the-accounting-cycle-the-10/ The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.

Treasury stock is a contra equity account that is entered as a negative value on the balance sheet of public companies. It shows the amount of funds used to repurchase previous issuances of stock, reducing the total number of shares outstanding. They are also accessible via the general ledger, trial balance, and some cash flow statements. Contra accounts with small balances may not appear separately, but may be combined with the asset account, subtracting the contra balance from the asset balance. Contra accounts that are combined into the asset value and not shown as separate line items are noted in the footnotes of the balance sheet.

Understanding Inventory Reserve

Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid). Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Check out the best bookkeeping and accounting blog known to man. (Ok, that might be a bit of an exaggeration.) Or, to skip straight to some more intermediate business tips, take a look at our introduction to S-Corps. You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated.

The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.

(Or so we’ve been told.) Reach out to us today for all of your bookkeeping and business consulting needs. A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines. For its day-to-day operations, the business maintains a fleet of 75 identical 2016 Ford Explorer limousines, each initially retailing at $150 thousand. However, these vehicles inventory contra account have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from large corporates and banks, as well as fast-growing start-ups.

• Contra equity accounts reduce the total amount of the owner’s, or shareholders’, equity.
• Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings.
• In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory.
• By using contra inventory accounts, financial statement users can gain a more accurate and detailed understanding of the company’s inventory position, allowing for better financial analysis and decision-making.
• Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account.
• There are common accounting terms like assets, liabilities, and equity that individuals and small business owners quickly become familiar with, and some like debits, receivables, and contra assets that require more research.