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. Obsolete, Unsold and Unusable Inventory are contra asset accounts with a credit balance that reduce the normal debit balance of the main Inventory asset account in order to present the net value of inventory on a company’s balance sheet.
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.
By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. 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. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account.
Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. Generally in the financial statements the revenue account would be offset against the contra revenue account to show the net balance. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance.
If a customer returns $500 of this merchandise, Company K will debit Sales Returns and Allowances for $500 and will credit Accounts Receivable for $500. Company K’s income statement will report the gross Sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales of $99,500. The contra asset account https://www.wave-accounting.net/the-best-guide-to-bookkeeping-for-nonprofits/ carries a credit balance because an asset account usually has a debit balance. Such accounts are allowance for doubtful accounts and the accumulated depreciation account. Contra accounts appear on the same financial statement as the related 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. As mentioned, contra asset accounts usually have a negative value which is the same as a credit balance. That is to completely or partially offset the balance of their related asset accounts. Asset accounts usually have a positive value which is the same as a debit balance.
Most accounts receivable would just be the time between purchase and credit card settlement. 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. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold.
A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. 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 Donations for Nonprofits and Institutions net amount is often referred to as the carrying amount or perhaps the net realizable amount. 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.
You would debit $50,000 as Accounts Receivable and credit $50,000 as Sales. If your client returns $1000 of the products bought, you record Sales Returns and Allowances worth $1,000 as debit and credit $1000 as Accounts Receivable. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.
Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance. 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 includes discounts on notes or bonds payable. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue.
Accumulated Depreciation is a contra asset that pairs with Fixed Assets. Accumulated Depreciation acts as a subaccount for tracking the ongoing depreciation of an asset. Each year of an asset’s life, another year of Depreciation Expense is recorded. The offset to the Depreciation Expense account is Accumulated Depreciation. 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.