What Is A Contra Account & Why Is It Important?

Once a seller proves adequate documentation, a third party may guarantee payment for the goods or services exchanged via a letter of credit. Discover features, types, requirements, and risks involved in the documents which are examples of a letter of credit. In this lesson, you will learn about the historical cost concept, look at examples of its application, and familiarize yourself with arguments for and against its use in accounting. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees.

Examples of contra expense accounts include Purchase Returns, Purchase Discounts, and Advertising Reimbursements. Similarly, the company may choose to combine the amounts in both its contra and fixed asset accounts if the contra asset account has a relatively low balance. Another reason to include contra accounts on a balance sheet is to preserve the historical value of the main account. This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position. This is especially true in cases where the contra account has a debit balance, as this will reduce the total amount of the corresponding account.

Types Of Contra Accounts

Definition of Contra Revenue Account A contra revenue account is a revenue account that is expected to have a debit balance . A contra revenue account allows a company to see the original amount sold and to also see the items that reduced the sales to the amount of net sales. Most companies rely heavily on the profit and loss report and review it regularly to enable strategic decision making. Are neither recorded in a journal entry nor posted to the general ledger accounts. Included with its bank statement a firm may receive a credit memorandum, which could indicate A. An allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported to reflect only the amounts expected to be paid.

The company uses Straight-Line Depreciation to track the loss of value of the asset over time. And discounts received to be maintained on the respective contra expenses account. 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. Similarly, accrued liabilities reduce the total amount of current liabilities. Contra accounts are used to help a company report the original amount of a transaction as well as reductions that may have happened.

Contra Expense Definition

Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts. Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue. The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense. For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. The difference between an asset’s balance and the contra account asset balance is the book value. Contra Liability a/c is not used as frequently as contra asset accounts.

To record a rent reduction, you would first need to set up a discount type of account in your QuickBooks that will be a contra-income account. A contra-income account is created to allow you to see the full amount of rent and discounts. It is a general ledger account with a purpose to have its balance to be the opposite of … Contra assets allow for more granular visibility on the balance sheet by maintaining historical costs and independent values rather than reducing the original account directly. There are various ways to compute the profitability of a company, such as gross margin, operating margin, return on assets, return on equity, return on sales, and return on investment.

Acc Accounts Receivable Quiz

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. Indian merchants had developed a double-entry bookkeeping system, called bahi-khata, predating Pacioli’s work by at least many centuries, and which was likely a direct precursor of the European adaptation. Accumulated depreciation is the total amount of depreciation expense allocated to a specific asset since the asset was put into use.

• This type of contra asset account may generally be debited expenses, followed by a credit to the company’s contra asset account for recording unusable inventory.
• Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset.
• A Contra Accounts is a general ledger account that is shown on the Financial Statements that is used to reduce the balance of its paired account.
• Discover features, types, requirements, and risks involved in the documents which are examples of a letter of credit.
• It is a general ledger account with a purpose to have its balance to be the opposite of …
• Contra revenue accounts appear near the top of the income statement, as a deduction from gross revenue.

For example, a company has determined that 5% of their accounts receivable in the amount of $15,000 will become uncollectible. Contra Accounts help show the net value of an account in the financial statements. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. Mark to market is a method of measuring the fair value of accounts that can fluctuate over time, such as assets and liabilities. She is an expert in personal finance and taxes, and earned her Master of Science in Accounting at University of Central Florida.

Units should consider using an allowance for doubtful accounts when they are regularly providing goods or services “on credit” and have experience with the contra expense account collectability of those accounts. The following entry should be done in accordance with your revenue and reporting cycles , but at a minimum, annually.

Asset Contra Account

It is not classified as a liability since it does not represent a future obligation. A contra account is a negative account that is netted from the balance of another account on the balance sheet. The two most common contra accounts are the allowance for doubtful accounts/bad debt reserve, which is subtracted from accounts receivable, and accumulated depreciation, which is subtracted from fixed assets.

The contra equity account reduces the total amount of shareholders’ equity. We recommend that you create a contra income account to track the scholarships that you’ve granted to students. This account will hold a debit balance as opposed to a credit balance in a typical income account. Therefore, a contra asset account is credited in order to reduce the amount of the asset. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset.

The sales discount account represents the discount amount a company gives to customers as an incentive to purchase its products or services. The discount on notes payable reduces the total amount of the note to reflect the discount given by the lender. Examples of contra liabilities include a discount on notes or bonds payable. Contra liability accounts are not as popular as contra asset accounts. Companies that issue bonds are likely to use contra liability accounts. Debits and credits are traditionally distinguished by writing the transfer amounts in separate columns of an account book. Alternately, they can be listed in one column, indicating debits with the suffix «Dr» or writing them plain, and indicating credits with the suffix «Cr» or a minus sign.

What Are Examples Of Contra Liabilities?

Contra expense accounts have a natural credit balance, as opposed to the natural debit balance of a typical expense account. This type of account can equalize balances in the asset account that it is paired with on a business’s balance sheet. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited separately. A contra expense account is a ledger account that is used to offset specific expense accounts such as accumulated depreciation account, purchase…

• Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance.
• 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.
• Under the accrual accounting method, expenses are recorded when they are incurred whether payment has been made or not.
• In addition, it aids in diminishing the tax burden by offering low-interest rates on monthly installments.
• The totals show the net effect on the accounting equation and the double-entry principle, where the transactions are balanced.

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Example Accumulated Depreciation

They serve an invaluable function in financial reporting that enhances transparency in accounting books. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. A company creates allowances for doubtful accounts to record the portion of accounts receivable which it believes it will no longer be able to collect. The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company. Contra AssetDepreciation is an example of a contra asset because it reduces the carrying balance of property, plant & equipment (PP&E) while providing tax benefits since depreciation reduces pre-tax income.

• Liability accounts record debts or future obligations a business or entity owes to others.
• The following are several key reasons why it can be important to include contra asset accounts on a balance sheet.
• A contra account is an account with a balance opposite the normal accounts in its category.
• 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.
• Peggy James is a CPA with over 9 years of experience in accounting and finance, including corporate, nonprofit, and personal finance environments.
• The information featured in this article is based on our best estimates of pricing, package details, contract stipulations, and service available at the time of writing.

Long-Term Assets are parent accounts that contain the original acquisition cost of fixed assets. Contra liabilities reduce liability accounts and carry a debit balance. Contra revenue accounts reduce revenue accounts and have a debit balance. The difference between an asset’s balance and the contra account asset balance is the book value. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.

Contra Liability Account

For a particular account, one of these will be the normal balance type and will be reported as a positive number, while a negative balance will indicate an abnormal situation, as when a bank account is overdrawn. Debit balances are normal for asset and expense accounts, and credit balances are normal for liability, equity and revenue accounts. 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.

A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance. https://www.bookstime.com/ Two common contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

One of these is the accumulated depreciation account, which marks the total amount of a depreciation expense of a specific asset. This should be used when a company has assets that have lost value over time because it allows a company to show both the cost of the asset and the actual value of the asset on a balance sheet.

In return, investors are compensated with an interest income for being a creditor to the issuer. To clarify, assume that a firm, ABC Corp. maintains a balance sheet with routinely updated debit and credit details. It may be negative or positive and is stated on the right side of the accounting book to counterbalance the debit portions. Purchases Returns account which is maintained against Purchases account is contra-expense account.

Each of the following accounts is either an Asset , Contra Account , Liability , Shareholders’ Equity , Revenue , Expense or Dividend account. Nowadays, as everything is shifting to the online platform, offline is mail is probably the fastest thing to be replaced by email.

Such usage is normally not allowed, but may happen for insignificant and incidental items. This determination can sometimes be difficult; consult with DFA for assistance. A purchase return allowance is where the buyer may return their item for a refund or keep it at a reduced price. Learn how to account for purchase returns and what allowances should be made to keep things running smoothly.

In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses. The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers.