Contra Account Definition, Types, and Example
Since liabilities are recorded with credit entries, contra liabilities show a debit balance. A contra liability acts more like an asset account because it is recorded as a debit and benefits the business’s bottom line by decreasing the liabilities. Examples of contra liability accounts include financing fees and original issue discounts (OID). 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 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.
- Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds.
- A contra liability account is not classified as a liability, since it does not represent a future obligation.
A negative balance, or credit entry, in an asset account, usually indicates a mistake or is accompanied by an explanation. Contra assets are a rare exception as they are recorded as a credit balance and appear as a negative number. A debit entry in a contra asset account is unnatural and most likely indicates an incorrect journal entry. There are common accounting terms like assets, liabilities, and equity that individuals and small business owners quickly become familiar with, and some like debits, receivables, and contra assets that require more research.
The Contra Equity Account
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. Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock. The LIFO method places a higher rate of cost on all the goods that a company sells over the period of a year. With reports that show a higher cost to the company, it also means that less income eligible for taxes is reported alongside it.
When offset against the related inventory account, the contra account results in a lower reported level of inventory in the financial statements. A contra inventory account is a type of account in financial accounting that offsets the balance of a corresponding inventory account. Contra inventory accounts have a credit balance, which is the opposite of the typical debit balance found in inventory accounts. The purpose of a contra inventory account is to reduce the total inventory value shown on the balance sheet by reflecting specific adjustments, allowances, or write-downs related to the inventory. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
- Tracking a company’s inventory reserve allows that company to make a more accurate representation of its assets on the balance sheet.
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- These contra revenue accounts tend to have a debit balance and are used to calculate net sales.
- Contra accounts with small balances may not appear separately, but may be combined with the asset account, subtracting the contra balance from the asset balance.
Tracking a company’s inventory reserve allows that company to make a more accurate representation of its assets on the balance sheet. By using contra inventory accounts, financial statement users can gain a more accurate and detailed understanding of the company’s inventory position, allowing for better financial analysis and decision-making. In its general ledger, differential cost accounting for managers the business will want to capture its gross sales figures and the actual value of the discount. There is almost always a story behind data; a clarification or historical insight that changes the meaning behind raw figures. In a report, layering on that additional context can be easy, but in a general ledger, you have few options for conveying nuance and subtlety.
In order to create a balance between the two methods and to give a fuller picture of a company’s financial realities, the LIFO reserve account is necessary. For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date. 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. Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing.
What is a Contra Inventory Account?
This is specifically important when sharing things like tax returns with the government because it means the amount of taxes the company accrues is likely to be lower. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Accounting software can simplify the management of and reporting from your ledger. With the appropriate level of automation integration in your chosen tool, you can pull the relevant values into these individual accounts directly from invoices, credit agreements, and other documentation.
The Contra Revenue Account
These contra revenue accounts tend to have a debit balance and are used to calculate net sales. 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. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.
To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value. This price gap — or discount — would then be recorded in a Discount on Notes Receivable account, and when the total of this contra account is combined with the parent account, you’ll be able to determine the net value of any outstanding notes. A contra revenue represents any deductions or offsets that need to be removed from gross revenue to provide a clearer understanding of actual income — such as in the example just provided.
If you keep a lot of inventory in stock, chances are that some of the inventory will become obsolete. This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
How Are Contra Accounts Reported in Financial Statements?
The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. 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. The contra asset account, accumulated depreciation, is always a credit balance. This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account.
List of Contra Accounts
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. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. A contra asset is a negative account used in double-entry accounting to reduce the balance of a paired asset account in the general ledger. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement.
Inventory reserve definition
Contra asset accounts can be used in a variety of areas, but there are three contra asset examples that you should pay close attention to. A contra inventory account is especially useful when market prices are lower than inventory costs, which will trigger a lower of cost or market adjustment. A third possible use for the account is when some of the inventory is no longer listed in the bills of material for current products, and so will not be used. The use of an inventory reserve is considered conservative accounting, since a business is taking the initiative in estimating inventory losses even before it has certain knowledge that they have occurred. This unexpected one-time charge could have been avoided with an ongoing series of smaller charges to build an inventory reserve over the course of the year. As indicated above, the LIFO reserve is important for a company because it explains any differences between the LIFO and FIFO accounting methods.
For example, let’s say your accounts receivable balance is currently $11,500, but you’re not entirely sure that you’ll be able to collect the entire balance due. To account for this potential obsolescence, TechShop creates a contra inventory account called “Allowance for Obsolete Inventory” with a credit balance of $10,000. The contra account to the accounts receivable account is the allowance for doubtful accounts and is used to represent the amount of invoiced goods or services that the business does not expect to collect.
Without the inventory reserve entry, the value of the company’s assets would be overstated. The following are examples of commonly-used contra asset accounts you could create to better understand your business financials. However, it’s important to keep in mind that you can create any contra account you want to more clearly describe your business — this is not an exhaustive or definitive list. Using the allowance for doubtful accounts, the contra asset account will more accurately reflect your true accounts receivable balance and make sure sure that your financial statements reflect the most accurate information possible. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. In anticipation of this, the company will create an entry on the balance sheet called inventory reserve.