The actual amount of uncollectible receivable is written off as an expense from Allowance for doubtful accounts. Transactions made to contra accounts are presented on a company’s financial statements under the related account. Contra accounts are important because they allow a company to follow the matching principle by recording an expense initially in the contra asset account. 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. Conversely, for a contra asset account like depreciation, you would list all entries as a credit, carrying a negative total balance for the overall account.
Using the allowance for doubtful accounts, the contra asset account will more accurately reflect your true accounts receivable balance and make sure sure that your financial statements reflect the most accurate information possible. When the actual inventory goes obsolete, the company has to quantify them in the dollar value and make the adjustment. By this time, the obsolete inventory will be disposed, so it should be removed from the balance sheet. The company has to remove the inventory and reverse the allowance for obsolete inventory. The transaction will not impact the expense account on income statement as the company has already estimated and recorded the expense.
TechShop performs an inventory review and identifies that a portion of its inventory, worth $10,000, is likely to become obsolete due to new product releases and changing customer preferences. I am new to accounting and need to make Chart of Account for an Inventory Management Information System. On August 16, Medici Music discovers that two of the flutes it ordered from Whistling Flutes, LLC were slightly scratched. Whistling Flutes agreed to discount the flutes by $200 and Medici agreed to keep the flutes. This entry is very similar to the entry used under perpetual inventory, but instead of Inventory we use Purchase Returns and Allowances.
Similarly, if the parent account lists entries as debits, the contra account will appear as a credit. In this article, we’re going on a deep dive into what exactly a contra account is, how contra accounts work, why top 10 sallie krawcheck quotes and how you would use contra accounts and more. The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet.
The other method for writing off inventory, known as the allowance method, may be more appropriate when inventory can be reasonably estimated to have lost value, but the inventory has not yet been disposed of. Using the allowance method, a business will record a journal entry with a credit to a contra asset account, such as inventory reserve or the allowance for obsolete inventory. Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining.
This would let users of the financial statements calculate the book value of the liability. An inventory reserve is an asset contra account that is used to write down the value of inventory. The account contains an estimated charge for inventory that has not been specifically identified, but which the accountant expects to write down the value at which it is currently recorded.
The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers. The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. This is an owner’s equity account and as such you would expect a credit balance.
A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. We know the amount of the sale has changed along with the amount owed on the receivable. Does the seller have more or less value in the Inventory account because of the allowance? Whistling Flutes has the same amount of value in inventory that it had before the transaction. In other words, contra revenue is a deduction from gross revenue, which results in net revenue.
Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. Some premium financing programs are sold under the assumption that the policy will have a substantial market value at the end of the term. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. Master accounting topics that pose a particular challenge to finance professionals. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.