What Are Contra Accounts? Definition, Types, and Examples

The difference between an asset’s account balance and the contra account balance is known as the book value. 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. And why stop at just theory when you can apply what you’ve learned using premium templates? Upgrade your productivity and performance with ready-to-use accounting templates designed to streamline contra account management.

Enrich your expertise by diving into online courses that dissect advanced accounting concepts, many of which come with coveted CPE credits to boot. You could explore comprehensive webinars and workshops focused on the nitty-gritty of contra accounts. These accounts can be listed based on the respective asset, liability, or equity account to reduce their original balance. Dividends payable arise when a company declares dividends to shareholders but has not yet distributed funds. This liability reflects the company’s commitment to reward investors, typically from retained earnings.

How to Record a Contra Account

Instead, you need to record this value gap, and a contra asset account serves that purpose. A contra revenue represents any deductions or offsets that need to be removed from gross revenue to provide a clearer understanding of actual income  —  such as in the example just provided. These accounts will typically help track sales discounts, product returns, and allowances (e.g., a price reduction for a good with minor defects). If the amount in a contra liability account is immaterial, it could reasonably be combined into a single balance sheet line item with the liability that it is intended to offset.

Furthermore, if you subsequently pay off that debt early and capture a discount, the contra liability account — Discount Notes Payable — would record those savings. Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds. Contra accounts are more commonly paired with asset accounts, such as accounts receivable or inventory, to reduce the carrying values of those assets. The credit balance in the liability account Bonds Payable minus the debit balances in the contra-liability accounts Discount on Bonds Payable and Bond Issue Costs results in the carrying value or book value of the bonds. The credit balance in Notes Payable minus the debit balances in Discount on Notes Payable is the carrying value or book value of the notes payable.

Why should one include contra accounts on a balance sheet?

• Such accounts are allowance for doubtful accounts and the accumulated depreciation account.
• Journal entry item related to contra liability account can possibly be identified with the often used word “discount”.
• Understanding their purpose, types, and application is fundamental for accounting professionals and learners alike to ensure accurate financial reporting and informed decision-making within organizations.
• 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.
• Namely, within a ledger, each account is intended to contain transactions and balances of a similar type only.
• These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.

The Allowance for Doubtful Accounts is used to track the estimated bad debts a company my incur without impacting the balance in its related account, Accounts Receivable. An estimate of bad debts is made to ensure the balance in the Accounts Receivable account represents the real value of the account. Allowance for Doubtful Accounts pairs with the Bad Debts Expense account when doing adjusting journal entries. In order to keep the accounts receivables as clean as possible capital campaigns with their historical values, we will use this contra account called allowance for doubtful accounts. There is the existence of contra accounts in accounting which are accounts that have the purpose of decreasing the value of another specific account if the two accounts are netted or summed together.

Examples of Contra Liability Account

By tracking contra accounts, a company can make more informed decisions about asset management, liability settlement, and overall financial planning. Therefore, to ensure accounts receivable stays clean and transparent, CCC will record $2,500 in the contra asset account called “Allowance for Doubtful Accounts”. This will ensure the net value of accounts receivable at year-end is not overstated. Contra asset accounts are presented on the balance sheet as reductions from the asset accounts they relate to. They typically appear just below the related asset, with their credit balances reducing the total value of the assets, showing the net amount that’s carried on the books.

What is a Contra Expense Account?

Once declared, the amount becomes a liability until payment is made, usually within weeks. For example, a $0.50 per share dividend on 1 million shares results in $500,000 recorded as dividends payable. Unearned revenues, or deferred revenues, arise when a company receives payment for goods or services it has yet to deliver. This liability represents an obligation to fulfill the transaction in the future and is common in subscription-based services, software licensing, and event ticketing. For instance, a streaming service collecting annual subscription fees upfront records these payments as unearned revenue until the service is provided over time.

• But in the real world, converting all of that potential into hard cash is highly unlikely, if not impossible.
• The purpose of the Sales Returns account is to track the reduction in the value of the revenue while preserving the original amount of sales revenue.
• Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance.
• If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $5 thousand in discounts during that same timeframe.
• Maintaining an accurate accounts payable ledger is essential for financial reporting and compliance with accounting standards like GAAP or IFRS.
• For instance, the “Accumulated Depreciation” contra account offsets the value of fixed assets like machinery or buildings, reflecting their reduced value over time due to wear and tear.

Types of Contra Account

For example, employee salaries earned but unpaid by month-end are recorded as accrued expenses. This aligns with the accrual basis of accounting, which recognizes expenses when incurred rather than when paid. These examples illustrate how contra accounts are used in various contexts to provide a more accurate picture of a company’s financial position and performance. Contra accounts are an essential component of the accounting process, designed to reflect the true value of assets, liabilities, equity, or revenue of a business. They provide a more nuanced picture of a company’s finances, allowing stakeholders to make informed decisions based on realistic, transparent financial information.

To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together. To reflect the reduction in change in accounting estimate examples the equipment’s value due to depreciation, the company also records $10,000 in the Accumulated Depreciation account. After one year, the Equipment account shows $40,000 ($50,000 – $10,000), and Accumulated Depreciation shows $10,000.

For the purpose of financial statement reporting, the amount on a contra account is subtracted from its parent account gross balance to present the net balance. 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. Imagine a company that offers an early payment discount to its customers, reducing their invoiced amount by 5% if paid within one week of invoicing. In a given month, asset turnover ratio explanation formula example and interpretation the company generates $100 thousand in gross sales but provides a total of only about $2 thousand in discounts that month.