Contra Accounts

Question

I was explaining contra accounts to a fellow student and was asked why the supplies account doesn’t have a contra account and why it would be incorrect to have a contra account for supplies when other assets such as equipment, inventory, and accounts receivable do. It’s not something I ever thought about before, I just knew that the supplies account normally doesn’t have a contra account (other accounts, such as prepaid insurance also typically don’t have a contra account). I know for accounts like equipment it is best to have a contra account so users can see more information including the historical price of the equipment, how much of its cost has been allocated so far, makes it easier to correct errors if an incorrect depreciation expense is recorded, and makes it easier if the company wants to change its depreciation method midway. Or when having accounts receivable, having its contra account is helpful to get a better idea of what percentage the company usually can collect from its customers and also easier to track down mistakes. I told the student having a contra account for supplies and prepaid insurance may not necessarily be wrong but it’s not something we typically do. My best guess on why we don’t make contra accounts for things like supplies and prepaid insurance is that it’s more unlikely to make a error in recording supplies and prepaid insurance (since we normally determine supplies expense by seeing how much supplies we have left and subtracting it from how much we started with to and since prepaid insurance is also more difficult to make a mistake in since it’s usually a uniform amount being expensed each time period). I also think it is because supplies is usually an insignificant amount compared to other asset accounts. These are my best guesses but I’m not certain. So could someone please explain why contra accounts for certain asset accounts like these usually don’t exist and if it’d be incorrect to have contra accounts for these accounts?

Answer 1

Contra accounts are required for certain accounts to either (1) preserve the original cost of an asset and to reflect the book value of an asset ,or (2) to correctly reflect the amount of Accounts Receivable a company expects to collect. This is required by GAAP for financial statement purposes to avoid overstatement of assets on the Balance Sheet.

On the other hand, Prepaid Expenses such as Supplies, Prepaid Rent, or Prepaid Insurance are expenses that are paid in advance. These are deferred expenses which will require adjusting entries to reflect the amount that has become expense in each reporting period, i.e., the amount of supplies that have been used, the amount of rent due in the period, and the amount of insurance which has expired. So, although Prepaid Expenses are treated as a current asset on the Balance Sheet, they do not require a contra-account.