Accruing tax liabilities in accounting involves recognizing and recording taxes that a company owes but has not yet paid. When the original dollar amount is kept in the original account and a separate account is used for recording the deduction, the resulting financial information becomes more transparent and helpful for stakeholders. 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. For example, you might offer bulk purchase discounts to large buyers but limit early payment discounts to customers who have shown reliability in the past. 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. 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.
Example #1: Revenue Contra Account
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. Given that liabilities have a credit balance, ensure that all your contra liabilities accounts have debit balances. Discount on notes payable and discount on bonds are examples of contra liability accounts. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. 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).
Understanding contra accounts
- 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.
- This allows stakeholders, including investors, lenders, and analysts, to have a clear view of the company’s revenue-generating activities and the impact of any deductions or discounts.
- Refine your return policies to be clear yet reasonable, balancing customer flexibility with business protection.
- Contra assets give investors a better picture of how you use your assets over time.
- So an Accumulated Depletion account would serve as the contra for the parent Fixed Asset account.
- Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds.
It will debit Accounts Receivable for $100,000 and will credit Sales for $100,000. 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 contra revenue account $500 and the resulting net sales of $99,500. Contra revenue refers to deductions or reductions in revenue that offset the gross revenue of a company. It represents the negative portion of revenue that arises from sales returns, discounts, allowances, and other types of deductions directly related to the company’s revenue-generating activities.
Types of Contra Accounts – Explanation
A normal asset has a debit balance, while a contra asset sits against this to show the net balance of both assets on your financial statement. Contra accounts allow you to show the amounts that offset a paired related account. As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets.
What is Contra Account?
It’s commonplace for businesses to encounter refund requests or returns from customers, and offering discounts is also a standard practice. The difference between an asset’s account balance and the contra account balance is known as the book value. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance.
- As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account.
- Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts.
- If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it.
- 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 asset accounts include allowance for doubtful accounts and accumulated depreciation.
In your income statement, the gross sales of $50,000 are offset by the sales returns and allowances of $1,000. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. The amount is reported on the balance sheet in the asset section immediately below accounts receivable. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
The purpose of a contra expense account is to record a reduction in an expense without changing the balance in the main account. The Allowance for Doubtful Accounts is used to track the estimated bad debts a company my incur without impacting the balance in its related account, Accounts Receivable. An estimate of bad debts is made to ensure the balance in the Accounts Receivable account represents the real value of the account. Allowance for Doubtful Accounts pairs with the Bad Debts Expense account when doing adjusting journal entries. A delivery van is purchased by a business to use in delivering product and picking up materials.
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