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Contra Accounts Recording, Understanding, Types, Example

What Is a Contra Account & Why Is It Important?

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Why is it called a contra account?

A contra asset account is a type of asset account where the account balance may either be a negative or zero balance. This type of asset account is referred to as "contra" because normal asset accounts might include a debit, or positive, balance, and contra asset accounts can include a credit, or negative, balance.

Contra accounts are shown in the financial statements below the paired accounts, although sometimes the balances of the two accounts are merged to a net amount for presentation purposes. Consider what would happen if you have sales on credit that you reasonably expect will not be paid. In the example of Homes Inc. the percentage of customers defaulting on the account, and the amount defaulted, is estimable and probable. Past experience with uncollected bad debt has been, on average, 10% of credit sales. The sale to the Johnson family will create a bad debt expense estimate of 10% of the amount receivable. The transactions made in this account are reported on a company’s financial statements directly under the related account. An allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported to reflect only the amounts expected to be paid.

What Is the Benefit of Using a Contra Account?

Discount allowed and received accounts for Sales or Purchases respectively. Mariel Loveland is a small business owner, content strategist and writer from New Jersey. Throughout her career, she’s worked What Is a Contra Account & Why Is It Important? with numerous startups creating content to help small business owners bridge the gap between technology and sales. Her work has been featured in publications like Business Insider and Vice.

  • The amount in the accumulated depreciation account is deducted from the assets of a company, such as buildings, vehicles and equipment.
  • A revenues account with a debit balance instead of the usual credit balance.
  • The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
  • This type of account can also be called the bad debt reserve or allowance for doubtful accounts.
  • Contra assets are a rare exception as they are recorded as a credit balance and appear as a negative number.
  • Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money.

Sale on account, which can also be known as a sale on credit or credit sales, refers to when businesses give a product over to a customer and customers do not have to pay until later. Credit sales are often risky because the chance of not collecting on the accounts receivable increases uncollectable percentages of credit sales, where the amount must be estimable and probable. Accounting for the contrary in a business will show the normal business account value, the attached contra account underneath it, with the net revenue the business experienced below. Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are.

What is a Contra Asset Account?

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. Another reason to include contra accounts on a balance sheet is to preserve the historical value of the main account. This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability. The amount on the equity contra account is deducted from the value of the total number of outstanding shares listed on a company’s balance sheet. A contra account is where we record events that are contrary to a general ledger parent account, also called a relating account. Contra accounts allow us to report the true value of a firm’s assets.

Drawing Account Definition – Investopedia

Drawing Account Definition.

Posted: Sun, 26 Mar 2017 03:33:17 GMT [source]

Contra accounts play a major role in estimating the book value of an asset. Treasury stock is a contra equity account that is entered as a negative value on the balance sheet of public companies. It https://accounting-services.net/ shows the amount of funds used to repurchase previous issuances of stock, reducing the total number of shares outstanding. Contra asset accounts appear as separate line items on the balance sheet.

Examples of Contra Accounts

The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The distinction between an asset’s account steadiness and the contra account steadiness is called the guide worth. Doubtful debts are those debts that a company believes will not be received in the future. This is deducted from the total of receivables to get the net receivables. Sales Returns account which is maintained against Sales account is basically contra-revenue account. Accounts in any business hold important information regarding different aspects of the entity and its operations. And to keep the information relevant and reliable these accounts needs to be updated to record all such transactions that relates to particular account.

Liabilities AccountsLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company. Contains the amount of sales discount given to customers, which is usually a discount given in exchange for early payments by customers.

Contra equity

It is because clubbing together dissimilar transactions impedes any analysis. For example, we need separate accounts to hold the actual cost of property, plant and equipment and related accumulated depreciation. If we record depreciation expense in the cost accounts directly, we will lose key information about the original cost of the assets and accumulated depreciation. To avoid this loss of important data, we record actual cost and depreciation in separate ledger accounts. Since the entry for cash sales is recorded as a credit in a revenue account, then a return on sales will be recorded as a debit in the revenue contra account, Return on Sales or Sales Returns and Allowances. Although you may be familiar with the normal balance requirements of each classification, a contra account will have the opposite requirement. Contra Asset AccountA contra asset account is an asset account with a credit balance related to one of the assets with a debit balance.

What Is a Contra Account & Why Is It Important?

The Johnson family is expecting visitors for the holidays and will need to furnish the spare bedroom. 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. Obsolete inventory reserves – This type of inventory counts as a loss for a business and includes any product that can no longer be sold or used because the product is defunct. Accumulated depreciation – This is the value of depreciated value shown on an asset over time.