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Difference Between Depreciation, Depletion, Amortization

• Let’s go over how they work and what the main types are, and then finish with an example.
• Inscrutable Corporation offers long-term disability insurance to its employees under an arrangement in which it pays for the insurance, and then participating employees reimburse it for half of this cost.
• These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.
• For industries that rely on natural resources — mining, logging, oil, gas — depletion tracks the gradual exhaustion of the raw material in question, offsetting that loss in value against the initial appraisal of the land.
• This indicates that out of $100,000 sales, your customers return goods valued at $500.
• Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.
• 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.

This means that the $85,000 balance is overstated compared to its real value. At this point, it isn’t known which accounts will become uncollectible so the Accounts Receivable balance isn’t adjusted. Instead, an adjusting journal entry is done to record the estimated amount of bad debt. Accumulated Depreciation acts as a subaccount for tracking the ongoing depreciation of an asset. Each year of an asset’s life, another year of Depreciation Expense is recorded. The offset to the Depreciation Expense account is Accumulated Depreciation.

Contra liability accounts

If you debit the contra account, ensure that you offset the related account with a credit balance. In essence, contra accounts allow you to report your firm’s gross and contra expense account net amounts. These accounts also ensure that you follow the matching principle in accounting, which states that you record expenses in the same period you incur them.

Cash Flow Statement

We will define what contra accounts are, the types of contra accounts and provide examples to illustrate. Although the car is normally an asset because you can sell it for parts or use it for your business, when the car depreciates to a zero or negative balance, it is a contra asset on your balance sheet. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. 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. As evident from the table below, each contra account has a parent account whose normal balance is often exactly opposite of the normal balance of the relevant contra account.

What Is a Contra Account?

The most common contra type, contra assets, records the loss in value of any asset accounts listed in your general ledger. And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business. Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes.

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Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. Inscrutable Corporation offers long-term disability insurance to its employees under an arrangement in which it pays for the insurance, and then participating employees reimburse it for half of this cost. In the first month of the arrangement, the company pays the insurer $10,000, which Inscrutable records in a long-term disability insurance expense account. It then records $5,000 of contra expense against this account, which is derived from deductions taken from employee pay.

Accumulated Depreciation as a Contra Asset

• Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month.
• Although the car is normally an asset because you can sell it for parts or use it for your business, when the car depreciates to a zero or negative balance, it is a contra asset on your balance sheet.
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• When the two balances are offset against each other they show the net balance of both accounts.
• When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000.
• A contra expense account is an account used to reduce the amount of an expense without changing the balance in the main expense account.