contra liability account definition and meaning

In other words, contra revenue is a deduction from gross revenue, which results in net revenue. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. The amortization of the financing fees reduces the pre-tax income (EBT) of the company and the company’s tax burden, i.e. the borrower benefits from these tax savings until the bonds reach maturity. The reason financing fees are an example of a contra liability is that the fees – much like interest on the debt – are amortized over the debt borrowing term. In spite of its name, contra liabilities function more similarly to assets.

  • In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount.
  • The two most common contra accounts on a balance are accumulated depreciation and the allowance for doubtful debts.
  • The purpose of the Accumulated Depreciation account is to track the reduction in the value of the asset while preserving the historical cost of the asset.
  • A debit will be made to the bad debt expense for $4,000 to balance the journal entry.
  • Contra accounts are crucial in reducing the balance on the paired account.
  • 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.

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. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. indirect reference definition This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable.

List of Contra Accounts

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. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. Contra accounts are more commonly paired with asset accounts, such as accounts receivable or inventory, to reduce the carrying values of those assets.

  • As mentioned above, these accounts also pair with a paired account and reduce its carrying balance.
  • 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.
  • Examples of contra assets include Accumulated Depreciation and Allowance for Doubtful Accounts.
  • 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.

In other words, contra accounts are used to reduce normal accounts on the 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. 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. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.

Contra Asset Accounting & Examples

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. Of that amount, it is estimated that 1% of that amount will become bad debt at some point in the future. This means that the $85,000 balance is overstated compared to its real value.

As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts. 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.

Contra Equity Account

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. In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount. A doubtful debts contra account allows for future write-offs of accounts receivable. Although you have not officially written off these debts yet, you show them to be a negative balance because you don’t believe the customer will pay you. Although the car is normally an asset because you can sell it for parts or use it for your business, when the car depreciates to a zero or negative balance, it is a contra asset on your balance sheet.

Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. 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. Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares. This depreciation is saved in a contra asset account called accumulated depreciation.

If the values are reported at net value, the users may not able to see how each of the elements has performed over the years. In the realm of accounting, various techniques are used to ensure financial statements provide an accurate and comprehensive view of a company’s financial health. One such method is the use of contra accounts, a type of account that directly correlates and offsets a related account. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset.

Adjusting Journal Entries Accounting Student Guide

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.

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. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable.

You debit the contra revenue accounts and credit the corresponding revenue accounts. For example, when you debit the balance in sales returns account, make sure that you offset the sales revenue account with a credit balance. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.

How to Set up Contra Accounts

Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset. With contra equity accounts, you reduce the number of outstanding shares you list on your company’s balance sheet. Treasury stock and owner’s drawing account are examples of contra equity accounts. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset.

Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. 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. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation. These items decrease the liability balance on the paired liability account.

Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. The difference between an asset’s account balance and the contra account balance is known as the book value. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately.

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