Accounting software can simplify the management of and reporting from your ledger. With the appropriate level of automation integration in your chosen tool, you can pull the relevant values into these individual accounts directly from invoices, credit agreements, and other documentation. A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines.
So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory. 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).
Contra Account Example: Allowance for Doubtful Accounts
The amount is reported on the balance sheet in the asset section immediately below accounts receivable. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet. This contra account holds a reserve, similar to the allowance for doubtful accounts. For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. At Invoiced, we provide a suite of solutions that work together to make managing your invoicing, accounts receivable, and accounts payable seamless and easy.
- When a contra asset account is first recorded in a journal entry, the offset is to an expense.
- These contra revenue accounts tend to have a debit balance and are used to calculate net sales.
- Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
But in the real world, converting all of that potential into hard cash is highly unlikely, if not impossible. Instead, you need to record this value gap, and a contra asset account serves that purpose. In its general ledger, the business will want to capture its gross sales figures and the actual value of the discount.
The account offsets the balance in the respective asset account that it is paired with on the balance sheet. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. 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.
While accumulated depreciation is the most common contra asset account, the following also may apply, depending on the company. As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account. But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss. In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account. The main advantage of using a contra asset account is to separate this reduction from the asset account with which it is paired.
Types of Contra Accounts
A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming.
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). A contra account provides missing context by pairing it with a related account. So as values shift depending on real-world factors, rather than making deductions or adjustments to the original or “parent” account, you would record these changes in the contra account instead. By viewing these accounts — the parent and contra — in tandem, business owners can gain broader insights, preserve the historical figures stored in the parent account, and make accommodations for any relevant changes. There is almost always a story behind data; a clarification or historical insight that changes the meaning behind raw figures.
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Conversely, for a contra asset account like depreciation, you would list all entries as a credit, carrying a negative total balance for the overall account. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. This account is paired with and offsets another asset account, so that a net balance is reported on the balance sheet. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset. 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. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
How Does a Contra Account Work in Accounting?
They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. Properly documenting these contra accounts in your ledger can sometimes feel counter-intuitive since they operate in an opposite manner from their parent accounts. Consider an asset account, where the values are listed as debits, and the account itself will present a positive total.
In a report, layering on that additional context can be easy, but in a general ledger, you have few options for conveying nuance and subtlety. Namely, within a ledger, each account is intended to contain transactions and balances of a similar type only. But sometimes, dissimilar transactions are important to consider together within a ledger. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time.
The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits.