Contra Account Definition, Types, and Example

Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. You’ll continue to use the contra asset account until the equipment has been completely depreciated, retired, or sold. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. 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.

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. Similarly, accrued liabilities reduce the total amount of current liabilities. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts. Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue.

Definition Of a Contra Account?

The difference between an asset’s account balance and the contra account balance is known as the book value. 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 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.

• Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
• The purpose of a contra account is to accurately report value of operating performance and assets for a firm.
• Increase in assets would be a great sign for an organization’s success.
• The contra asset account is later reduced when the expense is recorded.
• Accumulated depreciation is the most prevalent type of contra asset account.
• Usually, credit balances include items from one of those two natures.

The net quantity of fixed assets still in existence is revealed when the asset account and contra asset account are combined. Since a counter asset account does not represent long-term capital gains, it is not categorized bookkeeping for startups as an asset. 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.

Contra Equity Account

The credit will be to the asset account or allowance for doubtful accounts. 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.

• The auditors want to ensure that reserves are adequate, while the controller is more inclined to keep reserves low in order to increase the reported profit level.
• Note that in accounting, the term “book value” is also used interchangeably with net value.
• It offsets the balance of the related account, which means when the corresponding account is positive, a contra account will be negative.
• The sale to the Johnson family will create a bad debt expense estimate of 10% of the amount receivable.
• It usually nets off against related accounts and provides an opposite effect to the balance.

Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares. A contra account is a negative account that is netted from the balance of another account on the balance sheet.

Contra revenue account

The credit balance in the account Allowance for Doubtful Accounts tells us how much of the debit balance in Accounts Receivable is unlikely to be collected. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. 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.

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. In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers.

What is a Contra Asset 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. Contra liability accounts are less commonly used than contra asset accounts.

• The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable.
• Inventory is updated with the debit entry and the cost of goods sold is reduced with the credit.
• The use of Allowance for Doubtful Accounts allows us to see in Accounts Receivable the total amount that the company has a right to collect from its credit customers.
• Nova Incorporated is attempting to finalize their balance sheet in terms of the net value of their assets.
• Contra assets may be stated in separate line items on the balance sheet.
• Both the asset and the corresponding CA accounts must be stated clearly in the balance sheet.

Similarly, it allows companies to retrieve original account balances without complicated calculations. For stakeholders, looking at both accounts is also crucial in their decision-making process. The above accounts are the standard items that a company’s financial statements will include. However, there are other items as well that may not show in those financial statements. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.

After each accounting period, the company records a depreciation expense of the asset. Therefore, these companies must maintain an obsolete inventory reserve account to net off any unusable stock from the account. This requirement also comes from the accounting standard for inventories. A contra account is an account that companies use to reduce the value of a related account.

If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Any company that owns intangible assets such as software, patent, etc., will maintain https://marketresearchtelecast.com/financial-planning-for-startups-how-accounting-services-can-help-new-ventures/292538/ an accumulated amortization account. Similar to depreciation, this account plays a significant role in representing the book value of a company’s assets. A company creates allowances for doubtful accounts to record the portion of accounts receivable which it believes it will no longer be able to collect.