Offset account is the accounts present on the opposite side of another account and aims to reduce the balance of that account. It is also known as the contra account. The account contains the gross balance and it will reduce with the offset accounts to net balance.
For example, the fixed asset’s cost is the main balance or gross balance. Accumulated depreciation is the offset account that pair with the cost of fixed assets. We will get the net balance after combining both accounts.
Offset refer to the amount that reduces the balance of the opposite account. It helps the financial statement user to see both gross, offset, and net balance. It will be hard to understand if we show only the net amount.
Offset Accounts Example
Provision for bad debt or allowance for bad debt or allowance for an uncollectable account is the management estimate of receivable balance which is not going to be collected. It is the offset account that contra with accounts receivable. On the balance sheet, accounts receivable present on the debit side (positive) while the provision for bad debt is present on the credit site (negative). Both accounts will be offset and get the net balance.
|Less: Allowance for bad debt
- Provision for Bad Debt or Allowance for Doubtful Accounts:
- The provision for bad debt or allowance for doubtful accounts is an estimate made by a company to account for the possibility that some of its accounts receivable may not be collected.
- It represents an anticipated loss and is recorded as a contra-asset account, directly offsetting the accounts receivable on the balance sheet.
- Management Estimate:
- This estimate is based on historical data, industry benchmarks, economic conditions, and the company’s past experience with bad debts.
- Management makes an informed judgment to determine the amount of the provision.
- Balance Sheet Presentation:
- On the balance sheet, accounts receivable is presented as a current asset on the debit side (positive). This represents the total amount the company expects to collect from its customers.
- The provision for bad debt, being a contra-asset account, is presented on the credit side (negative). It reduces the total accounts receivable to reflect the more realistic net amount expected to be collected.
- Net Receivable Balance:
- The net balance is calculated by subtracting the provision for bad debt from the total accounts receivable.
- This net balance provides a more accurate representation of the amount the company expects to realize from its accounts receivable.
- Adjustments and Periodic Review:
- Companies periodically review and adjust the provision for bad debt based on changes in circumstances, customer payment behavior, and economic conditions.
- Income Statement Impact:
- When actual bad debts occur, they are written off against the provision for bad debt, and this impacts the income statement as an expense.
The accumulated depreciation account is the total of depreciation from the beginning to the current reporting date. It is the offset account of the fixed asset cost.
|Cost of Building
|Less: Accumulated depreciation of building
- Accumulated Depreciation:
- Accumulated depreciation is an accounting measure that represents the total depreciation expense recognized on a fixed asset from its acquisition to the current date.
- It is a contra-asset account, meaning it is deducted from the original cost of the asset on the balance sheet. The purpose is to reflect the gradual reduction in the value of the asset over its useful life.
- Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. This allocation is made to match the cost of the asset with the revenue it generates over time.
- Contra-Asset Account:
- The accumulated depreciation account is classified as a contra-asset account because it has a credit balance, which is opposite to the normal debit balance of asset accounts. This reflects that accumulated depreciation reduces the carrying amount of the related asset.
- Fixed Asset Cost:
- The original cost of a fixed asset is recorded on the balance sheet as an asset. As the asset ages, its value decreases due to factors like wear and tear, obsolescence, or the passage of time. Accumulated depreciation accounts for this decrease in value.
- Net Book Value:
- The net book value of a fixed asset is calculated by subtracting the accumulated depreciation from its original cost. This adjusted value represents the remaining value of the asset on the company’s books.
Obsolete inventory is the amount that a company needs to write off or write down due to various reasons such as expired, damaged, and other reasons. The company holds the inventory for a long time and does not expect to sell at full price.
|Less: Allowance for obsolete inventory
Obsolete inventory refers to goods or materials that a company holds in its stock but can no longer sell at their intended or original full price. This can occur for various reasons, including expiration, damage, changes in technology, shifts in market demand, or other factors that make the items unsellable at their initially expected value. Here are some additional details:
- Write-Off or Write-Down:
- When a company determines that its inventory is obsolete, it may choose to write off or write down the value of that inventory on its financial statements.
- Writing off obsolete inventory involves removing the entire value of the inventory from the accounting records. This is typically done when the inventory has no residual value or cannot be sold at any meaningful price.
- Writing down obsolete inventory involves reducing its recorded value to a lower amount, reflecting the reduced market value or the amount the company expects to recover from selling the inventory. This approach acknowledges that there might still be some recoverable value.
- Reasons for Obsolescence:
- Obsolescence can result from various factors, including changes in consumer preferences, technological advancements, seasonality, or regulatory changes. Items may become outdated, out of fashion, or simply no longer in demand.
- Impact on Financial Statements:
- Writing off or writing down obsolete inventory has an impact on the company’s income statement and balance sheet. It reduces the reported assets on the balance sheet and increases the cost of goods sold (COGS) on the income statement.
- Periodic Review:
- Companies regularly review their inventory to identify items that may be obsolete. This review ensures that the financial statements accurately reflect the true value of the inventory.
- Reserve for Obsolete Inventory:
- Some companies establish a reserve for obsolete inventory on their balance sheet. This reserve is an estimated amount set aside to cover potential future write-offs. It helps smooth the impact on financial statements over time.
Offset Accounts Journal Entries
Offset accounts are the contra account of the main account, and it usually on the opposite side which deducts the main account. The journal entries of the offset account will depend on each type of account below:
Provision for bad debt
Provision for bad debt will be recorded in contrast with the bad debt expense as following:
|Bad Debt Expense
|Allowance for bad debt
Accumulated depreciation will record in contrast with the depreciation expense:
Advantage of Offset Account
- Quick Calculation of Net Value: An offset account allows for a quick and transparent calculation of the net value. Instead of having to perform a separate calculation to determine the net amount, the offset account provides this information directly.
- Detailed Presentation: The use of an offset account allows for a detailed presentation of both gross and offset amounts. This transparency provides users with a clear understanding of the original gross value, the adjustments made through the offset account, and the resulting net balance.
- Compliance with Accounting Standards: Many accounting standards recommend or require the use of offset accounts rather than presenting net values alone. This practice ensures adherence to accounting principles and standards, contributing to the accuracy and consistency of financial reporting.
- Facilitates Understanding: For financial statement users, the presence of an offset account makes it easier to comprehend the figures presented. They can see not only the original amount (gross) but also the adjustments that have been made, leading to the net value. This transparency enhances the overall understanding of the financial position.
- Aligns with Transparency Principles: Transparency is a key principle in financial reporting. The use of an offset account aligns with this principle by providing a detailed breakdown of how the net value is derived from the gross value, making it clear and understandable for users.
- Enhances Analytical Capabilities: Users, such as investors, analysts, and other stakeholders, often need to analyze financial statements in detail. Having an offset account allows for a more granular analysis, enabling stakeholders to better understand the composition of balances and adjustments.