Contra asset definition
/What is a Contra Asset?
A contra asset is a negative asset account that offsets the asset account with which it is paired. The purpose of a contra asset account is to store a reserve that reduces the balance in the paired account. By stating this information separately in a contra asset account, a user of financial information can see the extent to which a paired asset should be reduced. A sample presentation of a contra asset appears in the following exhibit, where the accumulated depreciation line item offsets the total fixed assets line item; this presentation shows the fixed asset detail within a balance sheet.
The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits.
The proper size of a contra asset account can be the subject of considerable discussion between a company controller and the company's auditors. The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level. The amount of this reserve is typically based on the company’s historical loss experience for each reserve.
The Advantage of Using a Contra Asset Account
The main advantage of using a contra asset account is to separate this reduction from the asset account with which it is paired. By doing so, you can more clearly see the total amount of the related asset account, which would otherwise have been obscured by the offsetting amount of the reserve.
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Presentation of Contra Assets
Contra assets may be stated in separate line items on the balance sheet. Or, if they contain relatively minor balances, they may be aggregated with their paired accounts and presented as a single line item in the balance sheet. In either case, the net amount of the pair of accounts is referred to as the book value of the asset account in question. When a contra asset account is not stated separately in the balance sheet, it may be worthwhile to disclose the amount in the accompanying footnotes, where readers can readily see it.
Examples of Contra Assets
The allowance for doubtful accounts is a contra asset account, and it is paired with the trade accounts receivable account. When combined, the two accounts show the net amount of cash expected to be received from outstanding accounts receivable. As another example, the accumulated depreciation account is a contra asset account, and it is paired with the fixed assets account. When combined, the two accounts show the net book value of a company's fixed assets. (Note: It is customary to have one accumulated depreciation account and multiple fixed asset accounts with which it is linked.) Another contra asset is the reserve for obsolete inventory, which is less commonly used.