Types of Contra Accounts List of Examples Explanations Definition

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. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account.

We’ll need to dig into the footnotes to find out what the contra accounts are. 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. 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.

Obsolete Inventory

You must also report the amount that you can reasonably expect will not be paid, if it is estimable and probable. You could simply adjust the parent account…but then you are missing an essential part of the story — how many patients were actually treated today for a sprain. Accounting is how we tell a story about an economic event or financial transaction, such as a purchase or a withdrawal of money, for example. 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. Contra accounts provide more detailed information to financial statement users by showing both the gross and net amounts of the related accounts. They also help organizations track specific adjustments and discrepancies, allowing for better financial analysis and decision-making.

The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt. Depreciation is an offset of the value of PP&E (Property, Plant, and Equipment). The list of asset accounts on your general ledger and balance sheet conveys the combined, potential value of all of the tangible and intangible items that your organization possesses. But in the real world, converting all of that potential into hard cash is highly unlikely, if not impossible. Instead, you need to record this value gap, and a contra asset account serves that purpose.

What Is a Contra Account & Why Is It Important?

Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated Contra Accounts depreciation to reflect the accurate value of the asset. The amount for estimated uncollectible accounts is a bad debt operating expense. The allowance for doubtful accounts is the contra account that reduces the accounts receivable to an estimated realizable amount.

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. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. Each of these contra accounts serves to provide more detailed information about the transaction history of the related main account. By tracking contra accounts, a company can make more informed decisions about asset management, liability settlement, and overall financial planning.

Example Contra Account – Allowance for Doubtful Accounts

The most common contra account is the accumulated depreciation account, which offsets the fixed asset account. 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.

When considering all of the money currently owed to your business that’s recorded in your Accounts Receivable (A/R) line item as an existing asset, there’s a good chance that not all of those customers are going to pay you back in full. To compensate for those potential deadbeat customers, you can use a Bad Debts account to serve as a contra for your A/R. In this article, we’re going on a deep dive into what exactly a contra account is, how contra accounts work, why and how you would use contra accounts and more. There are many situations where one account is used to offset another account.

Types of Contra Accounts – Explanation

Some accountants will keep a reference handy to know if the debit increases or the credit increases an account. The normal balance of a contra account, and the debit or credit, will be the opposite of the entry and normal balance in the parent account. These examples illustrate how contra accounts are used in financial accounting to provide more accurate and detailed information about the related accounts, allowing for better financial analysis and decision-making. Let’s consider a fictional example of a small business called “TechGadget” to illustrate the use of contra accounts in financial accounting.

• Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account.
• For example, when your company borrows money, you would identify that debt in a Notes Payable account.
• 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.

Lenders should always compare AR and AP and look for contra/offsetting dollar amounts to the same company, individual, or related entity to ensure the value of receivables we’re lending against is accurate. Without a review of contra accounts, the institution may find itself significantly under collateralized should the company default on its credit facility. This general structure can be applied across all contra types, so if the parent account has a credit, the contra account will have a debit. Similarly, if the parent account lists entries as debits, the contra account will appear as a credit. As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account. But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss.

Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.

• The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account.
• Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.
• The December 5th journal entries record the original sale, and the December 12th entries record the return and exchange.
• This type of account could be called the allowance for doubtful accounts or bad debt reserve.
• By tracking contra accounts, a company can make more informed decisions about asset management, liability settlement, and overall financial planning.
• You could simply adjust the parent account…but then you are missing an essential part of the story — how many patients were actually treated today for a sprain.

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