The contra asset account carries a credit balance because an asset account usually has a debit balance. Such accounts are allowance for doubtful accounts and the accumulated depreciation account. Contra accounts appear on the same financial statement as the related account. For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts.
You may want to first classify contra accounts as contra asset accounts, contra liability accounts, contra equity accounts, or contra revenue accounts before accounting for any transaction. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable.
Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. The difference between an asset’s account balance and the contra account balance is known as the book value. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed statement sections percentage of goods or services that it has sold. 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.
- For example, a building is acquired for $20,000, that $20,000 is recorded on the general ledger while the depreciation of the building is recorded separately.
- Showing contra assets on your balance sheet allows potential investors to see how you write-down a depreciable asset, such as a piece of equipment.
- Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.
- For example, accumulated amortization is a contra asset account that reduces the balance for intangible assets.
- An example of a contra liability account is the bond discount account, which offsets the bond payable account.
In other words, contra revenue is a deduction from gross revenue, which results in net revenue. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. The amortization of the financing fees reduces the pre-tax income (EBT) of the company and the company’s tax burden, i.e. the borrower benefits from these tax savings until the bonds reach maturity. The reason financing fees are an example of a contra liability is that the fees – much like interest on the debt – are amortized over the debt borrowing term. In spite of its name, contra liabilities function more similarly to assets.
In other words, contra accounts are used to reduce normal accounts on the balance sheet. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
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. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable.
What is the Effect of Contra Accounts to the Balance of Related (Paired) Account?
For example, if your business has accounts receivable of $50,000 and an allowance for doubtful debts account totalling $5,000, the net accounts receivable is $45,000. In this way, a contra asset (credit) lowers the overall value of your accounts receivables (debit) on the balance sheet. A normal asset has a debit balance, while a contra asset sits against this to show the net balance of both assets on your financial statement. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. The most common contra equity account is called “treasury stock.” This special account decreases the number of shares outstanding in the market because the company repurchases some of the shares from its buyers.
- The monthly accounting close process for a nonprofit organization involves a series of steps to ensure accurate and up-to-date financial records.
- In spite of its name, contra liabilities function more similarly to assets.
- The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.
- Contra Liability a/c is not used as frequently as contra asset accounts.
Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset. With contra equity accounts, you reduce the number of outstanding shares you list on your company’s balance sheet. Treasury stock and owner’s drawing account are examples of contra equity accounts. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.
Understanding Contra Liability Accounts
The contra asset account of your equipment account is the accumulated depreciation of equipment. When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced. In the event that a contra account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult.
You debit the contra revenue accounts and credit the corresponding revenue accounts. For example, when you debit the balance in sales returns account, make sure that you offset the sales revenue account with a credit balance. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.
What Is the Benefit of Using a Contra Account?
A contra account is a general ledger account that offsets the balance of a corresponding account with which it’s paired. If you debit the contra account, ensure that you offset the related account with a credit balance. In essence, contra accounts allow you to report your firm’s gross and net amounts. These accounts also ensure that you follow the matching principle in accounting, which states that you record expenses in the same period you incur them.
Contra Account Examples
Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. 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 Stock Shares. This depreciation is saved in a contra asset account called accumulated depreciation.
What are Contra Accounts?
As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts. In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900.
They provide a more nuanced picture of a company’s finances, allowing stakeholders to make informed decisions based on realistic, transparent financial information. A contra expense account is an account used to reduce the amount of an expense without changing the balance in the main expense account. Examples of contra expense accounts include Purchase Returns, Purchase Discounts, and Advertising Reimbursements. Of that amount, it is estimated that 1% of that amount will become bad debt at some point in the future. This means that the $85,000 balance is overstated compared to its real value.