Contra Account Definition, Types, and Example

The first contra liability listed is an original issue discount (OID), a feature of debt financing wherein the issuance price is less than the redemption price. In spite of its name, contra liabilities function more similarly to assets. A Pareto analysis is a risk measurement approach that states that a majority of activity is often concentrated among a small amount of accounts. In many different aspects of business, a rough estimation is that 80% of account receivable balances are made up of a small concentration (i.e. 20%) of vendors. For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding.

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2. If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense.
3. Purchase Discounts, Returns and Allowances are contra expense accounts with a credit balance that reduce the normal debit balance of the main Purchase Expense account in order to present the net value of purchase expenses in a company’s income statement.
4. Instead of applying percentages or weights, it may simply aggregate the account balance for all 11 customers and use that figure as the allowance amount.
5. There are two major methods of determining what should be booked into a contra account.

Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance. Also, note that when writing off the specific account, no income statement accounts are used. This is because the expense was already taken when creating or adjusting the allowance. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

Financing fees refer to the payments issued to the 3rd parties engaged when arranging debt financing, i.e. the administrative costs charged by the lender, lender legal fees, etc. Suppose a bond is issued at a discounted https://simple-accounting.org/ price – i.e. lower than the redemption price (or the stated “par value”). Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

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. If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. 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.

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. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Note that if a company believes it may recover a portion of a balance, it can write off a portion of the account. 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). These examples are programmatically compiled from various online sources to illustrate current usage of the word ‘contradict.’ Any opinions expressed in the examples do not represent those of Merriam-Webster or its editors.

In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet. This type of account is a contra asset that reduces the amount of the gross accounts receivable account. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account.

What Are the Different Types of Contra Accounts?

Accumulated depreciation reflects the reduction in value of a fixed asset. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. The fixed asset account contains the original acquisition cost of a number of fixed assets, while the contra account (accumulated depreciation) contains the sum total of all the depreciation expense that has been charged against those assets over time. Taken together, the asset account and contra asset account reveal the net amount of fixed assets still remaining. A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. The difference between the gross balance of a main account and its contra accounts reported as the net balance in a company’s financial statements is also referred to as a book value, current value, carrying value, or net realizable value.

How Does a Contra Account Work in Accounting?

Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases. A company can further adjust the balance by following the entry under the “Adjusting the Allowance” section above. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.

The company must record an additional expense for this amount to also increase the allowance’s credit balance. 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. 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 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.

Example of a Contra 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. Accounts use this method of estimating the allowance to adhere to the matching contradebt principle. The matching principle states that revenue and expenses must be recorded in the same period in which they occur. Therefore, the allowance is created mainly so the expense can be recorded in the same period revenue is earned.

The company must be aware of outliers or special circumstances that may have unfairly impacted that 2.4% calculation. The sales method applies a flat percentage to the total dollar amount of sales for the period. For example, based on previous experience, a company may expect that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid.

Obsolete, Unsold and Unusable Inventory are contra asset accounts with a credit balance that reduce the normal debit balance of the main Inventory asset account in order to present the net value of inventory on a company’s balance sheet. Discount on Notes Receivable is a contra asset account with a credit balance that reduces the normal debit balance of its parent Notes Receivable asset account in order to present the net value of receivables on a company’s balance sheet. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation. 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. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances.

For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism. Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk. In this example, the company often assigns a percentage to each classification of debt.