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. The definition can be expanded to include contra accounts in general. Contra accounts act like regular accounts on the balance sheet but have a unique purpose. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated.
There are several examples of contra accounts, including accumulated depreciation, accumulated depletion, accumulated amortization, allowance for receivables, etc. These are all examples of contra-asset accounts, which are the prevalent type of contra accounts. As mentioned, contra asset accounts usually have a negative value which is the same as a credit balance. That is to completely or partially offset the balance of their related asset accounts.
- 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.
- Companies that hold inventories for a long time may face accumulating obsolete inventory.
- Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns.
- Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance.
When a contra asset account is first recorded in a journal entry, the offset is to an expense. 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. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. Therefore, contra-asset accounts differ from other accounts that have a credit balance.
Allowance for Receivables
Although contra-asset accounts have credit balances, they do not appear in liabilities or equity. Usually, credit balances include items from one of those two natures. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. Contra liability accounts are special accounts in the liabilities section of the balance sheet.
Treasury stock represents shares of a company’s own stock that it has repurchased from shareholders but not retired. Instead of increasing assets or decreasing liabilities (as would be typical when spending cash), buying treasury stock reduces shareholders’ equity. Specifically, it is contra to shareholders’ equity because it decreases the total shareholders’ equity on the balance sheet. Regardless of that, allowance for receivables accounts will exist for all companies that have account receivable balances. This account helps companies present a more accurate accounts receivable balance on the financial statements.
Contra Revenue Account
The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – contra asset account and its contra asset counterpart has a balance of $30,000. Therefore, the asset’s net value (or the book value) will be $70,000. 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 liability accounts
A contra liability account is not classified as a liability, since it does not represent a future obligation. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement. A second example of a contra asset account is Accumulated Depreciation. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately.
The accumulated depreciation account plays a vital role in representing the accurate value of an asset in the financial statements. In essence, contra-asset accounts have a negative balance while other asset accounts have a positive balance. Both of these accounts offset each other to represent a net balance on a company’s balance sheet. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts.
Contra asset accounts are necessary for companies for various reasons. The most prominent of these include allowing companies to present a more accurate picture of their assets. Instead, the existence of contra-asset accounts for companies will differ based on a company’s requirements.
Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets. In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.
Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.