A contra asset is a negative asset account that offsets the balance in 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.
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 resulting contra asset balances can be negotiated figures.
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.
For example, 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.
Examples of other contra assets are:
- Accumulated depletion
- Reserve for obsolete inventory
These additional accounts are less commonly used.