Contra asset account

From CEOpedia | Management online

Contra asset account in accounting is a type of account in which a credit balance prevails over a debit balance. In practice, additions registered on contra asset account are put on in the second coulmn (the right side) (Masoom 2013, p. 177). Each debit account is related to another credit account so that asset accounts have their contra asset account equivalents (carrying value). The characteristic feature of a contra asset account is decreasing the final value accomplished in the settlement. The name of this accounts relates to the word against, which has the same meaning as the word contra. It points out to the fact that every account of this type is in opposition to another - asset account. This explanation clarifies also the aspect of value reduction in the case of every contra account. Contra asset account is one of four used in accounting. Apart from this type, there exist also: liability, equity and revenue types.

Examples

Some examples of operations in which the contra asset account is used are:

  • Bank loan default - an example of usage of this type of account is the situation of bank loan default. The income is than left on the side of assets, in opposition to eventual loss (Mallett 2012, p.2.).
  • Sales and leaseback gains - in the analysis of Robert Sprouse, a contra-account with no accounts as contraposition under ABP 1964b is a category for sale and leaseback gains (Swieringa 2011, p. 212.).
  • Certificates - the contra asset account seems to be the right solution also as a way of accounting classification of - exemplary - Sukuk certificate. Unlike another solution, this one combines including the assets in the balance sheet and emphasize the fact that the true owners of the asset are Sukuk holders (Biancone, Shakhatreh 2016, p. 102-103.).
  • Allowance for doubtful accounts position - classical example of contra asset account use.

Contra-asset approach

Contra-asset approach could be treated as an alternative for all-inclusive income approach in the situation of a dangling credit. In this case, the credit is perceived as contra-assetand registered in connection with intangible assets (Graham 2015, p.66.). This gives the possibility of recording individual net assets on the market. At the same time, the procurement is cost-valued. When a situation of unreliable values of an acquired firm occurs, those uncertain assets are registered at the contra-asset account. Any higher sum than at the contra account is perceived as company's loss. The contra-asset approach requiring annual control and thorough reporting is nowadays seen as quite conservative in comparison with the current regulations and with the alternate solution - all-inclusive income approach. On the other hand, it may prove to be worth considering for companies seraching for modern solutions, that are relatively safe at the same time.

Advantages of Contra asset account

A contra asset account can be beneficial for a company in several ways:

  • It keeps the balance sheet organized, by offsetting the balance of an asset account with the balance of a contra asset account. This allows the business to easily identify the net value of the asset.
  • It offers additional flexibility in the reporting of expenses and revenue. For example, a contra asset account can be used to report depreciation expense.
  • It can also be used to track bad debts and other losses, which can be reported as an expense on the income statement.
  • Contingent liabilities can also be reported in a contra asset account. This can be useful for companies that have a large number of contractual obligations, such as leases or long-term debt.
  • Finally, it can be used to track the value of assets that have been sold or retired from the balance sheet. This allows a business to accurately track the value of its assets, even if they have been sold or retired.

Limitations of Contra asset account

  • Contra asset accounts have certain limitations that should be taken into consideration when deciding to use them. These limitations include:
  • The contra asset account must be set up in the correct manner in order to be effective and must be recorded accurately. If errors are made in the recording of the contra asset account, it can lead to inaccurate financial reporting.
  • Contra asset accounts must be monitored closely to ensure that the balance remains accurate. If the balance is not monitored, it can lead to the overstatement or understatement of the contra asset account.
  • Contra asset accounts can be difficult to set up, especially for those who do not have experience with setting up and maintaining accounting systems.
  • The use of contra asset accounts can be costly, as they require more time and effort to maintain. This can be especially true if the contra asset account is not monitored closely.
  • Contra asset accounts can be complex and difficult to understand for those who are unfamiliar with accounting terminology and concepts. Therefore, it is important to understand the mechanics of setting up and maintaining a contra asset account before attempting to use one.

Other approaches related to Contra asset account

In addition to the traditional approach of using Contra asset accounts, there are several other approaches that can be used to track the credit balances relative to debit balances. These include:

  • Recognizing the credit balance as a separate asset in the balance sheet - this approach recognizes the credit balance as a separate asset in the balance sheet, which is then offset against the corresponding debit amount.
  • Recording the credit balance on a separate line in the balance sheet - this approach records the credit balance as a separate line in the balance sheet, which is then offset against the corresponding debit amount.
  • Reclassifying the credit balance as a separate line item in the income statement - this approach reclassifies the credit balance as a separate line item in the income statement, which is then offset against the corresponding debit amount.
  • Recording the credit balance as a deferred income tax liability - this approach records the credit balance as a deferred income tax liability, which is then offset against the corresponding debit amount.

In summary, there are various ways to track the credit balances relative to debit balances, such as recognizing the credit balance as a separate asset in the balance sheet, recording the credit balance on a separate line in the balance sheet, reclassifying the credit balance as a separate line item in the income statement, and recording the credit balance as a deferred income tax liability. Each of these approaches has its advantages and disadvantages, and should be carefully considered when selecting the appropriate approach.


Contra asset account — recommended articles
Accounts uncollectible — T account — Abbreviated accounts — Creative accounting — Opening entries — Deposits in transit — Substance over form — Reversing entry — Prepaid income

References

Author: Joanna Możdżeń

Retrieved from "https://ceopedia.org/index.php?title=Contra_asset_account&oldid=90754"