There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
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Obsolete, Unsold and Unusable Inventory are contra asset accounts with a credit balance that reduce the normal debit balance of the main Inventory asset account in order to present the net value of inventory on a company’s balance sheet. Discount on Notes Receivable is a contra asset account with a credit balance that reduces the normal debit balance of its parent Notes Receivable asset account in order to present the net value of receivables on a company’s balance sheet. Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural find a tax preparer credit balances. Therefore, for these three, the debit balance actually represents a negative amount. A contra liability is a general ledger account with a debit balance that reduces the normal credit balance of a standard liability account to present the net value on a balance sheet.
The exact process can vary depending on the specific contra account and the accounting practices of the company. However, the fundamental principle is that the contra account is used to offset the related main account, providing a more nuanced view of the company’s financial position. Each of these contra accounts serves to provide more detailed information about the transaction history of the related main account. By tracking contra accounts, a company can make more informed decisions about asset management, liability settlement, and overall financial planning. Companies that issue bonds are likely to use contra liability accounts. If the bond is sold at a discount, the company will record the cash received from the bond sale as “cash”, and will offset the discount in the contra liability account.
Example #1: Revenue Contra Account
In the realm of accounting, various techniques are used to ensure financial statements provide an accurate and comprehensive view of a company’s financial health. One such method is the use of contra accounts, a type of account that directly correlates and offsets a related account. Unearned revenue is not a contra revenue account because it records deferred earnings for prepaid goods and services that are yet to be delivered and earned in the future, which are reported as a standard liability with a normal credit balance on a balance sheet. The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement. A debit will be made to the bad debt expense for $4,000 to balance the journal entry.
By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid).
Contra Account Example: Allowance for Doubtful Accounts
The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. In other words, contra revenue is a deduction from gross revenue, which results in net revenue.
- Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account.
- Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.
- Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares.
- Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.
If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it.
Contra accounts help provide more accurate financial information by separating certain items and highlighting their impact on the overall financial position. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). Hence, the “Accounts Receivable, net” line item on the balance sheet adjusts for the allowance to display a more realistic value of A/R and the cash payments to be received, so investors are not misled or caught off guard by sudden decreases in a company’s A/R. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.
Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation. Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. Examples of equity contra accounts are Owner Draws and Repurchased Treasury 36 business expense categories for small businesses and startups Stock Shares. Contra revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances. Discount on Bonds Payable is a contra liability account with a debit balance that reduces the normal credit balance of its parent Bonds Payable liability account in order to present the net value of payables on a company’s balance sheet.
For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.