What Is a Contra Account? The Motley Fool

Given that liabilities have a credit balance, ensure that all your contra liabilities accounts have debit balances. Discount on notes payable and discount on bonds are examples of contra liability accounts. Asset accounts are debit balances on the trial balance and the balance sheet. For example, accumulated amortization is a contra asset account that reduces the balance for intangible assets. 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.

There are two major methods of determining what should be booked into a contra account. If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. For example, a company has an accounts receivable balance of $30,000 for the year ended 31st December 2019. Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. The primary purpose of a contra account is to ensure the accuracy of the main account.

Contra equity accounts

Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. Note that in accounting, the term “book value” is also used interchangeably with net value. In accounting, refunds are handled through a contra-revenue account known as the sales returns and allowances account, reports Accounting Coach. When you issue a refund, you make a refund double entry, which means you must adjust two separate accounts in your records. Contra liabilities are common in companies that sell bonds to raise capital.

• Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts.
• Be sure to enter the contra account on the opposite column of the account they’re offsetting.
• It is not classified as a liability since it does not represent a future obligation.
• When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.
• 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.

However, that $1.4 billion is used to reduce the balance of gross accounts receivable. 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.

AccountingTools

Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. 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. Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. 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.

In essence, contra accounts allow you to report your firm’s gross and net amounts. 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. The account offsets the balance in the respective asset account that it is paired with on the balance sheet. The contra equity account treasury stock is reported right on the balance sheet.

Examples of Contra Accounts

A contra expense is an account in the general ledger that is paired with and offsets a specific expense account. Contra expense accounts have a natural credit balance, as opposed to the natural debit balance of a typical expense account. The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s 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.

On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification.

Contra revenue account

This depreciation is saved in a contra asset account called accumulated depreciation. 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. If there’s how to become a quickbooks proadvisor an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements. A contra account reduces the reported balance for the paired account.

Contra accounts allow you to show the amounts that offset a paired related account. As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records. Yes, one common example is the Allowance for Doubtful Accounts, which is a contra asset account that decreases a company’s Accounts Receivable.

It is a contra asset account and is directly related to the accounts receivable (asset). Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets. In case the CA 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.

What is contra asset account used for?

A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear 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. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance. Thus, the natural balance of a contra account is always the opposite of the account with which it is paired.

If contra assets appear in the credit column, record contra liabilities on side. 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. As mentioned above, these accounts also pair with a paired account and reduce its carrying balance.

The accumulated depreciation account is perhaps the most common contra asset account used by business owners. 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. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks. 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. In some sense, you can consider a contra asset as a negative asset. It is located in the long-term asset section of the balance sheet under the heading of property, plant, and equipment.

How does a contra account work?

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. The same is true for other asset accounts like accounts receivable. Accounts receivable is rarely reported on the balance sheet at its net amount.

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. Contra accounts are also helpful in recording temporary reductions in the original balances. Therefore, having them separate can ensure companies can track these changes easily. Contra accounts also allow companies to present the net value for these areas by reducing the original amount.