What is a Contra Account? Definition Meaning Example

Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account. Contra accounts are used to help a company report the original amount of a transaction as well as reductions that may have happened. They serve an invaluable function in financial reporting that enhances transparency in accounting books. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account. The December 5th journal entries record the original sale, and the December 12th entries record the return and exchange.

The accumulated depreciation account is designed to reduce the carrying value of the fixed asset account when depreciation is recorded at the end of each period. This means that entries recorded on the left side of the T-account will 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 a credit balance instead of a debit balance. Contra revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement.

What is Contra Account?

Therefore, contra asset accounts differ from other accounts that have a credit balance. Contra asset accounts are a type of contra account that net off against asset accounts. These include accumulated depreciation, accumulated amortization, allowance for receivables, obsolete inventory, and discount on notes receivables.

Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective»), an SEC-registered investment adviser. The sales allowance shows the discounts given to customers when returning the product. This is done to entice customers to keep products instead of returning them. The percentage of sales method assumes that a fixed percentage of goods or services sold by a company cannot be received. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups. The Johnson family is expecting visitors for the holidays and will need to furnish the spare bedroom.

What is a contra account?

Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. The contra asset account carries a credit balance because an asset account usually has a debit balance. Such accounts https://marketresearchtelecast.com/financial-planning-for-startups-how-accounting-services-can-help-new-ventures/292538/ are allowance for doubtful accounts and the accumulated depreciation account. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.

The net accounts receivable will more accurately report your assets on the balance sheet, and the estimated uncollectible expense will recognize the reduction to income in the same period as the sale. Instead, the existence of contra asset accounts for companies will differ based on a company’s requirements. However, there are some prevalent contra asset accounts that may exist for all companies. Your bank account, the inventory you currently stock, the equipment you purchase, and your accounts receivable balance are all considered asset accounts. Let’s say you have a truck worth $20,000 that will last five years. If you depreciated it evenly you would take $20,000, divide it by 5 and expense $4,000 each year.

Types of contra accounts

They find a nice set at Homes Inc. that includes a queen size bed, dresser, nightstand, and luggage rack. They want to take advantage of the interest free year of credit, so on December 5th they open a store account for the entire balance of $7,500 and make arrangements for delivery of the queen size bedroom set. If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR until 2024, an insane cash back rate of up to 5%, and all somehow for no annual fee. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R). The accounting entries for accumulated amortization are as follows.

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 impact to the income statement includes the original sale, the contra account for returns, and the debit to expenses for estimated uncollectible based on net receivable. The balance sheet impact includes the remaining account receivable after returns and the estimated uncollectible. The contra asset account, accumulated depreciation, is always a credit balance.

Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. 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. On the other hand, accumulated depreciation is a contra asset account.

Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent.