Contra liability account definition

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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. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance.

In the above example, accumulated depreciation is a contra account of machinery. Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account. Treasure stock is a good example as it carries a debit balance and decreases the overall stockholders’ equity. The debit balances in the above accounts are amortized or allocated to an expense, such as Interest Expense over the life of the bonds or notes payable. Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts.

  • Each of these contra accounts serves to provide more detailed information about the transaction history of the related main account.
  • Paul Boyce is an economics editor with over 10 years experience in the industry.
  • In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance.
  • Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.

If the amount in a contra liability account is immaterial, it could reasonably be combined into a single balance sheet line item with the liability that it is intended to offset. Or, if the contra liability account balance is immaterial, the accounting staff could elect not to keep a balance in the account at all. When the amount is material, the line item is typically presented separately on the balance sheet, below the liability account with which it is paired.

Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets. In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. A contra account always offsets the balance of a corresponding account.

Chart of Accounts Listing of Typical Contra Accounts:

The reason you show a contra asset on a balance sheet is so you can see the overall net balance of a particular asset and to give investors a more accurate look into your company’s financial activity. A contra account is an account that is used to offset another account. ‎wave invoicing on the app store The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of. When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset.

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. Make sure that you report contra accounts on the same financial statement as the related accounts. If you’re the one managing your company’s books of accounts, be sure to report the contra account on your financial statement on the line item directly beneath the main account. When the amount recorded in the contra revenue accounts is subtracted from the amount of gross revenue, it equals the net revenue of a company. In case a customer returns a product, the company will record the financial activity under the sales return account. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet.

Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. The reason for recognizing a contra liability is to reduce the corresponding account for amounts that cannot be realized or collected, while not adjusting the historical cost. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account. Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability.

An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. 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.

Accumulated Depreciation acts as a subaccount for tracking the ongoing depreciation of an asset. A Fixed Asset is a Long-term Asset used by a company to create revenue. Each year of an asset’s life, another year of Depreciation Expense is recorded. The offset to the Depreciation Expense account is Accumulated Depreciation. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline.

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. The contra asset account, which is allowance for doubtful accounts, indicates the original (gross) amount you report in the accounts receivable. It also shows the carrying (net) amount of $19,000, which you report to your firm’s balance sheet. Examples of contra accounts include allowance for doubtful accounts, reserve for obsolete inventory, and accrued liabilities. Each of these accounts helps to offset another account on the balance sheet. For instance, the allowance for doubtful accounts reduces the net amount of accounts receivable, while the reserve for obsolete inventory does the same for inventory.

What is a Contra Liability?

At this point, it isn’t known which accounts will become uncollectible so the Accounts Receivable balance isn’t adjusted. Instead, an adjusting journal entry is done to record the estimated amount of bad debt. Accumulated Depreciation is a contra asset that pairs with Fixed Assets.

How to Present Contra Accounts on Financial Statements

Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. Note that in accounting, the term “book value” is also used interchangeably with net value. Therefore, the book value of an asset in the books is equal to its historical cost (the debit balance of the asset) minus the related amount of contra asset in the balance sheet (the credit balance of the contra asset).

Everything You Need To Master Financial Modeling

Contra liability accounts are not as popular as contra asset accounts. 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.

If the balance in your allowance for doubtful accounts has a credit of $1,000 and your accounts receivable has $20,000 in normal debit balance, then the net value of the receivables is $19,000. 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. Contra assets give investors a better picture of how you use your assets over time. The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible.

Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation.

The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment. The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. Similarly, its underlying balances also appear on the credit side of the trial balance. However, a contra equity account is a debit balance that reduces the balances reported on equity accounts. For example, treasury stock is a common type of contra equity account.

If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries. 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. However, that $1.4 billion is used to reduce the balance of gross accounts receivable.