What Is A Contra Account & Why Is It Important?

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. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance .

A second example of a contra asset account is Accumulated Depreciation. Sometimes a shareholder’s equity account may show negative balance. This negative amount is reduced from the total equity of a company. This can also be referred to as outstanding shares that appear on the balance sheet of a company.

Definition Of ’contra Account’

Without this account, the user may not know about the adjustments made to the value of machinery. Serenesurface January 28, 2011 I used to run a small store and one customer was also a supplier of goods for me. Initially, I tried to keep track of sales and purchases together in one account but this quickly became very confusing and difficult to keep up with. The contra account separated the pay account and the account in which I received payments.

• In an accounting system, ledger accounts are designed to contain similar classes of transactions.
• By the same token, an account with a credit would be balanced by a contra-asset account.
• Now that I have thoroughly dated myself, let’s get into contra accounts.
• Sales has a credit balance; its contra accounts, Sales Discounts and Sales Returns and Allowances, have debit balances.
• 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.
• The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable.

As evident from the table below, each contra account has a parent account whose normal balance is often exactly opposite of the normal balance of the relevant contra account. It is an account with the opposite balance to the asset account, with which such contra account is related. Contra account is the opposite account, related to the main account. The aim of contra account is to reduce balance of the main account and provide a separate and clear data in the accounting on the substance of such decrease. As the name indicates, sales return accounts are maintained to record the return of goods by customers, if any.

Accumulated depreciation reduces costs of asset and contra account is used to have cost value and accumulated depreciation separately. A bills payable account is another contra liability account that is created to record any discount received by the other party. Bills payable is an agreement written on behalf of the seller stating that a company will make payment on a future date. If the company pays before the maturity date, the granter may offer some reduction or discount, which is recorded in the contra account. A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account. Contra accounts are used to ensure the proper valuation of these items is reflected on the balance sheet. From the bank’s point of view, when a debit card is used to pay a merchant, the payment causes a decrease in the amount of money the bank owes to the cardholder.

Bills Payable Meaning

Therefore, a contra asset can be regarded as a negative asset account. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. The difference between a normal account and a contra account is that, if there is a debit balance in the normal account, you will have the opposite balance in the contra account. In the case of an accumulated depreciation account, the asset account always has debit balance, whereas a contra account will show a credit balance.

• Its value indicates how much of an asset’s worth has been utilized.
• Sometimes a shareholder’s equity account may show negative balance.
• Obsolete inventory refers to a company’s products or goods that have become obsolete, or unusable, during routine use and operations.
• Therefore, the depreciation of the equipment increases by approximately $50,000 for each year of use.
• Because of the oppositional nature of these asset accounts, the contra account acts as a ‘contrary’ element to the debit balances of regular asset accounts.

Some balance sheet items have corresponding “contra” accounts, with negative balances, that offset them. Examples are accumulated depreciation against equipment, and allowance for bad debts against accounts receivable. United States GAAP utilizes the term contra for specific accounts only and does not recognize the second half of a transaction as a contra, thus the term is restricted to accounts that are related. For example, sales returns and allowance and sales discounts are contra revenues with respect to sales, as the balance of each contra is the opposite of sales .

Attributes Of Accounting Elements Per Real, Personal, And Nominal Accounts

The lender may offer the company a discount if it repays the note early. The discount on notes payable reduces the total amount of the note to reflect the discount given by the lender. A contra account offsets the balance of a corresponding account. Transactions made to contra accounts are presented on a company’s financial statements under the related account. Contra accounts are important because they allow a company to follow the matching principle by recording an expense initially in the contra asset account. The contra asset account is later reduced when the expense is recorded.

All of this information is reported on the balance sheet so that it is easier for the readers to understand the financial position of the company. For example, a company has total fixed assets worth of $50,000 for the year ended 2019.

What Does Contra Account Mean?

Accumulated depreciation account, which is asset contra account. Note that the Balance Sheet is not affected with the result of the above entry as the cash flow is between two asset accounts. As an example, if the value of machinery is $500,000 at the end of the year, this is the net value of the machinery. This value is obtained after reducing the depreciation amount. This will be shown using a contra account called an accumulated depreciation account.

Doubtful debts are those debts that a company believes will not be received in the future. An account is created in the name of allowances for doubtful debt. This is deducted from the total of receivables to get the net receivables. The first known recorded use of the terms is Venetian Luca Pacioli’s 1494 work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita .

Types Of Finance And Accounting Jobs

The contra revenue accounts commonly used in small-business accounting include sales returns, sales allowance and sale discounts. A contra revenue account carries a debit balance and reduces the total amount of a company’s revenue. The amount of gross revenue minus the amount recorded in the contra revenue accounts equal a company’s net revenue. A transaction is made under the sales return account when a customer returns a product to the company for a refund. Sales allowance represents discounts given to customers to entice them to keep products instead of returning them, such as with slightly defective items. The sales discount account represents the discount amount a company gives to customers as an incentive to purchase its products or services. Therefore, a contra asset account will show the opposite balance – the credit balance.

Is an account with a balance that is the opposite of the normal balance of a related account. At the end of the first year, the net value of the equipment would be $300,000 – $50,000 in accumulated depreciation, so the net value of the equipment at the end of the first year would amount to $250,000. Sales Discounts –Sales discounts are offered on sales of goods to attract buyers. Sales Allowances-Sales allowances are also a part of the sales account. Sales allowance is the reduction in the selling price when a customer agrees to accept a defective unit instead of returning it to the seller.

Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. Yes, I’m taking a little liberty here, but the concept is the same. My receivable to my neighbor is completely wiped out by the offset payable due to the value of the saw. When the interest is paid you could debit interest payable and credit cash. If you have the security deposit as your asset, then the investment is an asset with interest accrued in credit account interest revenue .

Contra accounts are also applicable for Income Statement accounts. These accounts have to be closed at the end of the accounts period in the same way as the main Income Statement accounts are being closed. So the interest expense and interest payable can be listed separately to the security deposit amount owed as interest obligation on the funds deposited.

From the bank’s point of view, your debit card account is the bank’s liability. From the bank’s point of view, when a credit card is used to pay a merchant, the payment causes an increase in the amount of money the bank is owed by the cardholder. From the bank’s point of view, your credit card account is the bank’s asset. Hence, using a debit card or credit card causes contra account definition a debit to the cardholder’s account in either situation when viewed from the bank’s perspective. Debit cards and credit cards are creative terms used by the banking industry to market and identify each card. From the cardholder’s point of view, a credit card account normally contains a credit balance, a debit card account normally contains a debit balance.

Contra accounts are made as subsidiaries of original accounts. Maintaining a contra account is important as it provides more clarity on the dealings of a company. It clearly shows how the balances are offset and helps in establishing the matching principle. Contra accounts help the user of the financial statement to get clear information, which helps in making the statement more understandable.

To avoid this loss of important data, we record actual cost and depreciation in separate ledger accounts. However, it will be meaningless to show the property plant and equipment cost account and the related accumulated depreciation account separately on the balance sheet. We need to show the net book value of the property plant and equipment which equals the cost of PPE offset by related accumulated depreciation which is a contra account. An accumulated depreciation account is a type of contra asset account that is used for recording the amount of depreciation a fixed asset evolves through. For instance, a fixed asset such as machinery, a company building, office equipment, vehicles or even office furniture would be highlighted in an accumulated depreciation account. This amount may appear on a company’s balance sheet, and it can ultimately result in a reduction in the gross amount of a business’s fixed assets. A liability that is recorded as a debit balance is used to decrease the balance of a liability.

Because of the oppositional nature of these asset accounts, the contra account acts as a ‘contrary’ element to the debit balances of regular asset accounts. Furthermore, a contra asset account may also be regarded as a negative asset account because equalizing an asset account and contra asset account results in the asset’s net, or total, balance. This means that entries recorded on the left side of theT-accountwill increase the asset balance and entries recorded on the right side will decrease it. Contra asset accounts have a balance that is opposite from the regular asset accounts. In other words, a contra asset account maintains acredit balance instead of a debit balance. As mentioned above, the primary situation in which contra asset accounts appear has to do with accumulated depreciation.

Accounts Receivable has a debit balance; its contra account, Allowance for Doubtful Accounts, has a credit balance. Equipment has a debit balance; its contra account, Accumulated Depreciation–Equipment, has a credit balance. Allowance for doubtful debt is a provision created for invoices that are expected to be uncollectible at some point in future years.

The two common contra liability accounts, discount on bonds payable and discount on notes payable, carry normal debit balances. The discount on bonds payable represents the difference between the amount of cash a company receives when issuing a bond and the value of the bond at maturity. Notes payable represents a liability created when a company signs a written agreement to borrow a specific amount of money.

The complete accounting equation based on the modern approach is very easy to remember if you focus on Assets, Expenses, Costs, Dividends . All those account types increase with debits or left side entries. Conversely, a decrease to any of those accounts is a credit or right side entry. On the other hand, increases in revenue, liability or equity accounts are credits or right side entries, and decreases are left side entries or debits. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.

Author: Mark Kennedy