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. Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers. The amount is not reported, and the net sales amount is reported on the income statement. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid). ABC Computers makes sales of 90,000; unfortunately, due to a fault in a product, they received returns of 2,500.

• Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented.
• So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory.
• Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.

Generally speaking, the use of contra accounts is to ensure their related accounts stay clean and to keep track of historical cost easier. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability. Whenever the balance of a contra asset account increases (credit to the contra asset account), the increased amount is written off as an expense and is reported in the company’s income statement. 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.

Recording Contra Accounts

The contra liability account would be used to offset the liability account on the balance sheet. Below is the asset account debit balance and accumulated depreciation account credit balance on the balance sheet. They are usually subcategory accounts linked to an account on the balance sheet. Contra accounts are used to offset each other and reduce the gross amount. For example, a contra accumulated depreciation account can offset a fixed asset. The contra accounts will be grouped in the same category on the balance sheet or income statement as their related accounts.

However, some asset accounts need a negative counterpart to reduce the balance of that account. The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset. Revenue is an income statement account, but it flows through to the equity section of retained earnings as well. Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.

Contra liability account example

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. Contra accounts play an important role in accounting by helping businesses track certain aspects of their finances more accurately. For example, contra revenue accounts can be used to track the full cost of sales less any discounts or returns. It can help businesses see the complete picture of their income and expenses.

Main Elements of Financial Statements: Assets, Liabilities, Equity, Revenues, Expenses

It can help companies see the complete picture of their income and expenses and their equity or net worth. The allowance for doubtful accounts is used to reduce the net income by the estimated amount of uncollected receivables. This account helps to give a more accurate picture of the company’s financial position.

Contra Asset Accounting & Examples

A contra account is an account used in a general ledger to reduce the value of a related account when the two are netted together. The term “contra” means “against,” which perfectly describes the role these accounts play in your finances – they are going against the norm. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet. The purpose of the Owner’s Withdrawal account is to track the amounts taken out of the business without impacting the balance of the original equity account.

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.

Each year of an asset’s life, another year of Depreciation Expense is recorded. The offset to the Depreciation Expense account is Accumulated Depreciation. The Notes Receivable account documents the total value of any promissory notes held by the company. Typically, these notes reflect purchases made on credit by your customers. To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value.

Contra asset account example

Examples of contra assets include Accumulated Depreciation and Allowance for Doubtful Accounts. Unlike an asset which has a normal debit balance, a contra asset has a normal credit balance because it works opposite of the main account. https://accounting-services.net/the-role-of-accounting-in-business-and-why-its/ Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances.

We will define what contra accounts are, the types of contra accounts and provide examples to illustrate. The purpose of a contra expense account is to record a reduction in an expense without changing the balance in the main account. Of that amount, it is estimated that 1% of that amount will become bad debt at some point in the future. This means that the $85,000 balance is overstated compared to its real value. At this point, it isn’t known which accounts will become uncollectible so the Accounts Receivable balance isn’t adjusted.

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. The following are examples of commonly-used contra asset accounts you could create to better understand your business financials. However, it’s important to keep in mind that you can create any contra account you want to more clearly describe your business — this is not an exhaustive or definitive list. The equity section of the balance sheet is where the shareholder’s claims to assets are reported.