It ensures that financial statements accurately reflect a company’s financial position. For instance, the « Accumulated Depreciation » contra account offsets the value of fixed assets like machinery or buildings, reflecting their reduced value over time due to wear and tear. A contra account is an essential concept in financial accounting that serves to offset the balance of another account. It plays a vital role in maintaining the accuracy and transparency of a company’s financial statements. Contra accounts are used to record adjustments, reversals, or reductions in the value of assets or liabilities.

Bad debt

Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining. A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life. Contra asset accounts contra asset allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset.

What Is a Contra Account?

Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds. Contra asset account is the asset account with a negative or no balance. This is the reason they are categorized as a contra account as the normal asset accounts have positive or debit balance. These contra assets in the balance sheet are reflected with the asset accounts they are paired with to equalize the balance. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting.

1. Purchase Discounts, Returns and Allowances Expense Contra

The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, personal finance education, top-rated podcasts, and non-profit The Motley Fool Foundation. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

The expense account uses its debit balance to reduce the revenue account’s credit balance. A liability recorded as a debit balance 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. 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.

AccountingTools

To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together. By providing a clear and transparent mechanism to account for adjustments, these accounts enable stakeholders, including investors and creditors, to better understand a company’s financial health. For instance, « Sales Returns and Allowances » is a contra account entry used to record returned merchandise or customer allowances, allowing a company to track and report these adjustments separately from regular sales revenue. A contra account is an account with a balance opposite the normal accounts in its category. Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts. In other words, contra accounts are used to reduce normal accounts on the balance sheet.

Nowadays, with the development of a computerized accounting system, it is easy and quick to prepare the contra asset accounts as the system does all the calculations, and hardly anything is pushed manually. However, an accountant or person in charge must ensure that any change in the value of the assets due to revaluation or impairment must be considered. Also, with IFRS (International Financial Reporting Standards) asking to report it in a particular way, the accountants must be updated with recent changes to how the contra assets account should appear in the books of accounts. With increasing globalization and companies operating in many countries, the books of accounts must be compatible with a global platform. They are also the result of globally accepted accounting principles for accurately reporting financial numbers. As we have seen in the above discussion, how reporting contra assets accounts helps in a better understanding of the financial statements of any organization.

Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. To offset this, the allowance for doubtful accounts balance is adjusted via a credit, while the bad debt account is debited to balance out the AR account. When combined, the AR account and the allowance for doubtful accounts contra assets offer a projection of how much net cash is expected to be received from outstanding accounts. Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances.

The list of asset accounts on your general ledger and balance sheet conveys the combined, potential value of all of the tangible and intangible items that your organization possesses. But in the real world, converting all of that potential into hard cash is highly unlikely, if not impossible. Instead, you need to record this value gap, and a contra asset account serves that purpose. 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. The account Allowance for Doubtful Account is credited when the account Bad Debts Expense is debited under the allowance method. The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers.

However, the details for contra accounts usually exist on the notes to the financial statements. However, these can cause a reduction in other balances on the statement. Nor would it count as a liability as it does not reflect a future obligation. 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.

The Allowance for Doubtful Accounts carries a credit balance that reduces the total amount of accounts receivable to show the amount that the company expects to collect. The most common contra type, contra assets, records the loss in value of any asset accounts listed in your general ledger. And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business.

Double Entry Bookkeeping

When considering all of the money currently owed to your business that’s recorded in your Accounts Receivable (A/R) line item as an existing asset, there’s a good chance that not all of those customers are going to pay you back in full. To compensate for those potential deadbeat customers, you can use a Bad Debts account to serve as a contra for your A/R. From studying the basics of debit and credit, balance sheet accounts have a healthy balance. These accounts facilitate auditing and financial analysis by providing a detailed breakdown of adjustments made during a specific accounting period. This information assists auditors, and financial analysts in evaluating a company’s financial performance and risk exposure.

It represents all the depreciation related to an asset or the company’s overall assets. Usually, companies add to the accumulated depreciation account after every accounting period. Every contra asset account on a company’s accounting records will also have a pairing account. For example, accumulated depreciation will go along with related assets.

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. When a good is sold on credit, the amount receivable from customers is shown under the debtor’s balance sheet balance.

This general structure can be applied across all contra types, so if the parent account has a credit, the contra account will have a debit. Similarly, if the parent account lists entries as debits, the contra account will appear as a credit. These accounts can be listed based on the respective asset, liability, or equity account to reduce their original balance.

After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Provision for a discount from creditors and discount on bills receivable are other widely used examples. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.