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What Is a Contra Account? The Motley Fool

What Is a Contra Account? The Motley Fool

Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. This discount is subtracted from the total amount borrowed to better reflect What Is a Contra Account & Why Is It Important? the discount given by the lender. 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.

What Is a Contra Account & Why Is It Important?

The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.

Understanding contra accounts

Accumulated depreciation offsets a company’s real property assets, such as buildings, equipment and machinery. This represents the cumulative amount of depreciation https://accounting-services.net/bookkeeping-huntsville/ expense charged against an asset. The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of.

  • Revenue is an income statement account, but it flows through to the equity section of retained earnings as well.
  • The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of.
  • On the other hand, the accumulated depreciation (Also see Impairment versus Depreciation of Fixed Assets) account offsets the business’s fixed assets such as buildings, equipment, and more.
  • The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported.
  • The contra liability account is less common than the contra asset account.

For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset. The amount of gross revenue minus the amount recorded in the contra revenue accounts equals a company’s net revenue. Such an entry is made under the sales return account when a customer returns a product to the company.

Importance of Contra Accounts

This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability. The use of a contra account enables a business to continue reporting the gross amount (original amount) and also report the net amount (carrying amount).

  • In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000.
  • Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance.
  • The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance.
  • The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock.
  • The accumulated depreciation amount shows how much depreciation expense has been charged against an asset.

Contra revenue accounts reduce revenue accounts and have a debit balance. An asset account normally carries a debit balance and so, the contra asset account that is related to the asset account will carry a credit balance. The most common contra asset accounts are the accumulated depreciation and the allowance for doubtful debts accounts. The allowance for doubtful debts account shows the amount that your business is unable to collect, and therefore, it offsets the accounts receivables. On the other hand, the accumulated depreciation (Also see Impairment versus Depreciation of Fixed Assets) account offsets the business’s fixed assets such as buildings, equipment, and more.

Contra Revenue Account

The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company. In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.” An item on one side of an account which offsets fully or in part on the opposite side of the same account is technically referred to as contra account. The discount on bonds payable amount shows the difference between the amount of cash received when issuing a bond and the value of the bond at maturity. For example, a building is acquired for $20,000, that $20,000 is recorded on the general ledger while the depreciation of the building is recorded separately.

Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities include discount on notes or bonds payable. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance.

In this way, an accumulated amortisation account offsets a related asset account (which is recorded as a debit). Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock. Creating allowances for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect. Such allowance for doubtful accounts offsets a company’s accounts receivable account. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.

This type is paired with the asset account, which allows a business to record the original price or value of the asset at time of purchase. The contra asset account then allows recording of the value factoring in depreciation. This type of account could be called the allowance for doubtful accounts or bad debt reserve.

Contra Asset Account

Examples of contra accounts include allowance for doubtful accounts, reserve for obsolete inventory, and accrued liabilities. 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. Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are.

What Is a Contra Account & Why Is It Important?

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