Offset Account in AccountingDefined with Types and Examples
What is an Offset Account?
When talking about offsetting in accounting, it usually refers to reducing or negating the balance of another account that it is paired with.
An offset account can also be referred to as a contra account and this means that offset accounts will always have a paired balance sheet account.
The most common types of offset accounts are accumulated depreciation (paired with fixed assets), reserve for obsolete inventory (paired with inventory), and drawings account (paired with capital).
When presented in the Balance Sheet, the net amount of an account will be shown as a single line item or its net value, or the balance sheet account is shown with the offset account just under it.
When companies offset account balances, it does not necessarily mean that offsetting is an accounting process.
Showing net balances is merely a presentation method – one which companies can decide whether to follow or not.
Examples of Offset Accounts
To fully understand how offset accounts work, let us look at a few examples below for a more complete illustration.
Accumulated Depreciation is an offset account paired with depreciable Fixed Assets.
Examples of depreciable assets are buildings, computers and software, furniture and fixtures, vehicles, machinery.
Accumulated depreciation brings down the value of fixed assets to its book value, representing the amount of depreciation that these assets accumulate each year until they are fully depreciated.
For example, the total fixed assets of a company amounting to $25,000 has recorded an annual depreciation of $5,000.
The accumulated depreciation of $5,000 is an offset account that reduces the amount of the fixed assets.
Where Fixed Assets have a normal debit balance, Accumulated Depreciation will have a normal credit balance.
To record the transaction above as a journal entry, the entry to be passed will be a debit to depreciation expense of $5,000 and a credit to accumulated depreciation of $5,000.
In the Balance Sheet, the total fixed assets and the accumulated depreciation will be shown as:
|Accumulated Depreciation – Fixed Assets||($5,000)|
|Fixed Assets, net||$20,000|
The drawing account is an offset account for the capital account.
The normal balance of capital is a credit so to offset its amount, a debit has to be passed which is the normal balance of a drawing account.
For example, a company has a total capital amount of $300,000.
During the year, the owner has made a total drawing of $100,000.
To record the amount drawn by the owner from the company, the journal entry is a debit to the drawing account for $100,000 and a credit to cash of $100,000.
In the Owner’s Equity section of the Balance Sheet, it will be presented as:
Based on the illustration above, the drawing account offset the capital account and reduced the amount of the capital by $100,000.
Allowance for Bad Debts
The Allowance for Bad Debts or Allowance for Doubtful Accounts is a type of offset account that estimates how much of the total Accounts Receivable will become uncollectible.
Companies who sell on credit make a reasonable estimate based on past experiences that some customers will never pay.
To record an allowance for bad debts, the account is usually credited in the journal entry.
The Accounts Receivables normal balance is a debit and in order to decrease its amount, the offset account must be its opposite which is a credit.
For example, a company has recorded a total sales of $450,000.
Out of that, the credit sales are $200,000.
Based on previous experience, 10% of the total credit sales becomes uncollectible.
The company will record the allowance for bad debts for $20,000 (10% of $200,000) as a debit to Bad Debts Expense and a credit to Allowance for Bad Debts.
In the Balance Sheet, the Accounts Receivable and Allowance for Bad Debts will be shown as:
|Allowance for Bad Debts||($20,000)|
|Net Accounts Receivable||$180,000|
Offset Accounts in Banking
When it comes to banking, offset accounts are also used in order to determine the Net Loan Balance of the borrower.
This works by pairing the borrower’s loan to their bank account.
In this case, it is the bank account that is considered an offset account.
The net loan balance is derived by reducing the cash bank balance from the outstanding loan amount.
The interest rate is then applied based on the net loan balance.
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