What Is a Contra Account & Why Is It Important? Chron com

Contra revenue accounts show the deducting adjustments to gross revenue or producing net revenue. Sales returned for a refund are posted to the contra account to reduce gross revenue or return on sales. The other side of the transaction is posted to cash because there is no value in retaining the sales transaction in the cash account. Accounting contra asset accounts or contra revenue accounts follow a simple double-accounting procedure to eliminate errors in financial reporting. The most common way to account for contra accounts is to attach the regular account with its connected contra account underneath it on a company’s balance sheet.

Contra accounts appear on the same financial statement as the related account. For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts. Allowance for doubtful accounts is netted from the accounts receivable balance. The company predicts which accounts receivable won’t be paid by customers and writes those off. When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account.

Recording contra entries

This allows the reader to see both the current and historical book values for a particular asset or liability. The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense. For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. For example, GAAP accounting (or generally accepted accounting principles) requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value.

Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the https://kelleysbookkeeping.com/the-5-best-tax-software-for-small-business-of-2021/ tax savings, so the balance sheet may not state the true value of fixed assets. However, if the billing office stopped there, you would overstate your assets and net income. You must also report the amount that you can reasonably expect will not be paid, if it is estimable and probable.

A Common Business Transaction That Would Not Affect Stockholders’ Equity

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. Examples of contra accounts include allowance for doubtful accounts, reserve for obsolete inventory, and accrued liabilities. Each of these accounts helps to offset another account on the balance sheet. For instance, the allowance for doubtful accounts reduces the net amount of accounts receivable, while the reserve for obsolete inventory does the same for inventory.

• These contra revenue accounts tend to have a debit balance and are used to calculate net sales.
• Money taken from office (cash) and deposited in bank − When amount is deposited in bank then it is recorded in the debit side of bank column of cash book.
• The net amount is often referred to as the carrying amount or perhaps the net realizable amount.
• This type of account can also be called the bad debt reserve or allowance for doubtful accounts.
• Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.
• Periodic financial statements report the impact of the story and are used by leaders of a firm or industry to analyze performance, plan, and respond.

Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. 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. The post-war SARO Princess prototype flying boat airliner also had eight of its ten engines driving contra-rotating propellers.

Contra liabilities

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. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. What Is The Purpose Of Contra A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Two propellers are arranged one behind the other, and power is transferred from the engine via a planetary gear or spur gear transmission.

For example, the depreciation value will be listed underneath the value of a vehicle, or the allowance of bad debts will be attached to the accounts receivable. Another example could be when a product is bought and is returned at face value because of a defect. The contra return on sales account will be debited while the normal cash account will be credited. 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.