For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts. The net realizable value of the accounts receivable is the accounts receivable minus the 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.
Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. The exact process can vary depending on the specific contra account and the accounting practices of the company. However, the fundamental principle is that the contra account is used to offset the related main account, providing a more nuanced view of the company’s financial position.
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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. In a sales returns and allowances contra revenue account, you offset the balance in the sales revenue account. When the contra account reads $500 and the normal credit balance is $100,000, then your net sales are $99,500.
Example Contra Account – Allowance for Doubtful Accounts
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. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance. Offsetting the asset account with its respective contra asset account shows the net balance of that asset.
- 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.
- 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.
- 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.
- Similarly, accrued liabilities reduce the total amount of current liabilities.
- Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. 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.
A contra liability account is not classified as a liability, since it does not represent a future obligation. You may use accounting software packages, such as QuickBooks Online to set up contra accounts. Simply hit Control + N under the Chart of Accounts or Edit, then click New (to create a new account). For example, when a line item on your balance sheet presents the balance of accounts receivable, report the value of allowance of uncollectible accounts below the accounts receivable line.
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Understanding Contra Accounts
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Sales Discounts Account
Contra accounts are shown in the financial statements below the paired accounts, although sometimes the balances of the two accounts are merged to a net amount for presentation purposes. Contra accounts are an essential component of the accounting process, designed to reflect the true value of assets, liabilities, equity, or revenue of a business. 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. Accumulated Depreciation is a contra asset that pairs with Fixed Assets.
Example of a Contra Account
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 equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
This indicates that out of $100,000 sales, your customers return goods valued at $500. 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. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. Contra liability, equity, and revenue accounts have natural debit balances.
Generally in the financial statements the revenue account would be offset against the contra revenue account to show the net balance. Contra account is important as it not only allows a company to report the original amount of a transaction but also report any reductions that may have happened so that the net amount will also be reported. They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value. Contra accounts serve an invaluable function in financial reporting that enhances transparency in accounting books. If a listed company purchases its own shares from the open market, it will have to debit the treasury stock account in order to record the transaction.
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.
Accumulated Depreciation acts as a subaccount for tracking the ongoing depreciation of an asset. Each year of an asset’s life, another year of Depreciation Expense is recorded. The offset to the Depreciation Expense account is Accumulated Depreciation. You can also record contra revenue within the welcome to bookkeepers com where we love bookkeeping! sales account, but this means that it will be buried within the total amount of revenue reported, so that management cannot easily determine the amount of contra revenue. If your company has minimal contra revenue activity, it is acceptable to record these transactions within the revenue account.
Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue. 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. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement.