When you enter an accounting entry, you often cancel it with an equal entry that is its opposite. This cancellation of one entry by another in the general ledger is a form of offsetting. However, offset accounting generally refers to the creation of contra accounts to offset, or net, one account from another on the balance sheet. Offset accounting also refers to the partial or full offsetting of debt of one party by another.
Offsetting is another term for netting. With offsetting, you show your company's assets and liabilities on the balance sheet on a net basis. In offset accounting, you decrease the total, or net, of a different account balance to create a net balance. Offsetting is purely a presentation method, not a type of accounting. You can only do this when your company has the legal right to offset or counter the position. Offsetting makes it easier to quickly determine an item's historical treatment and book value.
When you sell a product, you generate revenue. You also incur expenses. Ultimately, some portion of the sales revenue goes to profit. For example, a general ledger adjustment would be revenues, $500. This would be offset by expenses, $350, profits $150. When you obtain a term loan to purchase equipment and fund general operations, the general ledger adjustments are as follows: long-term liability -- term loan, $65,000; long-term asset, equipment, $50,000, short-term asset, cash, $15,000.
A contra account is a type of offset account used on the balance sheet. A contra account reduces the amount of the asset or liability. For example, say you own a building with an original purchase price of $250,000. The building's contra account, accumulated depreciation, shows a total of -$50,000. This amount offsets the purchase price total resulting in a book value of $200,000. This $200,000 equals the $250,000 you paid for the building less its $50,000 in accumulated depreciation.
Another component of offset accounting is offsetting debt. Offsetting debt occurs when your company allows another business to release all or a portion of the outstanding amount due on their debt or other monetary obligation to your company. You offset the debt by applying what the other business owes your company against the amount that your company owes them. You can do this if you have the right to do so, the other party agrees and the offsetting is allowed by law.
Say company A owes your company $20,000 on a note receivable for goods purchased. This note is due in full in three months. However, your company owes Company A $15,000 for services due on a net 60 invoice. Your billing department contacts Company A to inform them of your intent to offset the obligations. You then offset your company's obligation against Company A's debt. The net due from Company A is now $5,000.
