What Is a Contra Account? The Motley Fool

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. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Contra asset accounts are a type of contra account that net off against asset accounts.

A contra account is where we record events that are contrary to a general ledger parent account, also called a relating account. Contra accounts allow us to report the true value of a firm’s assets. The balance of the contra account will offset its parent account while still preserving the value of the transactions recognized in the relating account.

Contra Account

Sales discounts – Normal discounts given to the customers are recorded separately because of special circumstances. Normal discounts usually consist of a marketing strategy, when a customer purchases a large volume of product, or if a customer wants to make early payments on the product. 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. DepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life.

Asset accounts usually have a positive value which is the same as a debit balance. It shows deductions from the revenue of a company, which results in net revenue. A bills payable account is another contra liability account that is created to record any discount received by the other party.

What are Contra Accounts?

Debit cards and credit cards are creative terms used by the banking industry to market and identify each card. From the cardholder’s point of view, a credit card account normally contains a credit balance, a debit card account normally contains a debit balance. On the other hand, when a utility customer pays a bill or the utility corrects an overcharge, the customer’s account is credited. If the credit is due to a bill payment, then the utility will add the money to its own cash account, which is a debit because the account is another Asset. Again, the customer views the credit as an increase in the customer’s own money and does not see the other side of the transaction.

• As mentioned, a company will usually have debit balances in its asset accounts.
• Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers.
• A contra expense account will behave in the opposite way a normal expense account will; instead of debiting to increase, a contra account must credit to increase.
• Contra accounts are important because they allow a company to follow the matching principle by recording an expense initially in the contra asset account.
• Contra revenue accounts reduce revenue accounts and have a debit balance.
• However, it will be meaningless to show the property plant and equipment cost account and the related accumulated depreciation account separately on the balance sheet.

They are used in case some customers won’t be able to pay the money they owe to the business. The same is true for other asset accounts like accounts receivable. Accounts receivable is rarely reported on the balance sheet at its net amount. 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 percentage of receivables the company is writing off.

Contra Account – Explained

This post will explain what a contra account is and how it works to correctly show the value of a organization’s financial statements. It will also provide examples to show the effect of contra entries. Both the asset and the corresponding CA accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. The definition can be expanded to include contra accounts in general. Contra accounts act like regular accounts on the balance sheet but have a unique purpose.

The company may take buyback decisions if it thinks the stock is undervalued in the open market or it decides to pay dividends to shareholders. Sometimes a shareholder’s equity account may show negative balance. This negative amount is reduced from the total equity of a company. This can also be referred to as outstanding shares that appear on the balance sheet of a company.

Alternately, debits and credits can be listed in one column, indicating debits with the suffix “Dr” or writing them plain, and indicating credits with the suffix “Cr” or a minus sign. contra definition accounting Despite the use of a minus sign, debits and credits do not correspond directly to positive and negative numbers. Luca Pacioli knew a thing or two about keeping the records straight.

Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. These contras reduce the equity account and carry a debit balance. Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. The complete accounting equation based on the modern approach is very easy to remember if you focus on Assets, Expenses, Costs, Dividends .