What Is a Contra Account? The Motley Fool

The monthly accounting close process for a nonprofit organization involves a series of steps to ensure accurate and up-to-date financial records. To record these transactions, GadgetHub will create a contra expense account called “Purchase Discounts. The sales returns account contains either an allowance for returned goods, or the actual amount of revenue deduction attributable to returned goods.

  • To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts.
  • Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance.
  • These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.

Allowance for doubtful accounts is netted from the accounts receivable balance. The company predicts which accounts receivable won’t be paid by customers and writes those off. When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account. If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it. 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.

Definition of Contra Asset Account

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. 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. Purchase returns, allowances and discounts are all examples of contra expense accounts. The accounts normally have a credit balance and in use are offset against the purchases account which is normally a debit balance.

  • 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 this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account.
  • Contra equity reduces the total number of outstanding shares on the balance sheet.
  • A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.

The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. They are expenses that are offset against revenue, reducing the total amount of income reported on a company’s financial statement. 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. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find. Companies bury them in the footnotes and often don’t break out the actual calculation.

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). When the company pays the cost of having the flyer printed, a journal entry is done. The purpose of the Sales Returns account is to track the reduction in the value of the revenue while preserving the original amount of sales revenue. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

What Is the Benefit of Using a Contra Account?

In the financial statements the purchases account would be offset against the contra expense accounts to show the net purchases. For instance, if a company has a plant asset such as Equipment with a debit balance of $92,000 and the account Accumulated Depreciation has a credit balance of $50,000, the carrying amount (or book value) of the equipment is $42,000. The equity section of the balance sheet is where the shareholder’s claims to assets are reported. The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders.

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. A contra-liability account is a liability account in which the balance is expected to be a debit balance. Since a debit balance in a liability account is contrary to the normal credit balance, the account is referred to as a contra-liability account. Revenue is the income generated by a business through the sale of goods or services. Contra expense, on the other hand, is an expense that is offset against income in the same accounting period.

The Contra Equity Account

He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. When the two balances are offset against each other they show the net balance of both accounts. When researching companies, the financial statement is a great place to start.

How Are Contra Accounts Reported in Financial Statements?

An estimate of bad debts is made to ensure the balance in the Accounts Receivable account represents the real value of the account. Allowance for Doubtful Accounts pairs with the Bad Debts Expense account when doing adjusting journal entries. In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.” A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. A delivery van is purchased by a business to use in delivering product and picking up materials. The company uses Straight-Line Depreciation to track the loss of value of the asset over time.

Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. For example, GAAP accounting (or generally accepted accounting principles) requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value.

Contra Asset, Contra Liability and Contra Equity

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. A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear what is the cost of factoring in the financial statements directly below their paired accounts. Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance.

Free Financial Statements Cheat Sheet

A contra expense account is a type of account in financial accounting that offsets the balance of a corresponding expense account. Contra expense accounts have a credit balance, which is the opposite of the typical debit balance found in expense accounts. The purpose of a contra expense account is to reduce the total expenses shown on the income statement by reflecting specific adjustments, recoveries, or reimbursements related to the expense. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account.