Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing. If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $10 thousand in discounts during that same timeframe. In reality, the actual number of company discounts came closer to $5 thousand. Now, if that sounded like a lot of mumbo-jumbo jargon to you, don’t worry. 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.
The Contra Liability Account
Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds. 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. The contra liability account is less common than the contra asset account.
Why are contra asset accounts important for businesses?
- A key example of contra liabilities includes discounts on notes or bonds payable.
- In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance.
- Rather than pay this cost up-front and tie up a significant chunk of capital, Show-Fleur makes this purchase on credit with a 90-day due date after invoicing.
- One other type of account is the contra account and for accountants, this is a must-know.
- This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000.
For instance, to increase asset and expense accounts, we simply record a debit and to decrease those accounts, we can record a credit. Each account in a general ledger will be designated debit or credit accounts depending on whether they’re categorized as assets, liabilities, revenues or expenses. In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory. As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account.
Cash Flow Statement
The amount on the equity contra account is deducted from the value of the total number of outstanding shares listed on a company’s balance sheet. Contra account is important as it not only allows a company to report the original amount of a transaction but also report any reductions that may have happened so that the net amount will also be reported. They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value. 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. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account.
A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines. For its day-to-day operations, the business maintains a fleet of 75 identical 2016 Ford Explorer limousines, each initially retailing at $150 thousand. However, these vehicles have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand. In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later. The auditors aim to keep the balances at their adequate levels, but the controller might want to keep them as low as possible to reduce expenses and maximize profit levels.
What is a Contra Revenue Account?
Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what what is a contra account percentage of receivables the company is writing off. To oppose the revenue made by a company, contra revenue accounts must have a debit balance.
- This is done to entice customers to keep products instead of returning them.
- It is not classified as a liability since it does not represent a future obligation.
- Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts).
- Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost.
- The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
- For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date.
Sales Allowances
- The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation.
- By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company.
- By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount.
- The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable.
- Accounting software can simplify the management of and reporting from your ledger.
- For this reason the account balance for items on the left hand side of the equation is normally a debit and the account balance for items on the right side of the equation is normally a credit.
CCC estimates that 5% of accounts receivable will most likely be unrecoverable. CCC bought equipment and machinery worth $100,000 at the beginning of the current financial year and estimates that the equipment and machinery will depreciate by $10,000 every year. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. When the two balances are offset against each other they show the net balance of both accounts.
Normal Balances of Accounts Chart
