The amount is not reported, and the net sales amount is reported on the income statement. In order to keep the accounts receivables as clean as possible with their historical values, we will use this contra account called allowance for doubtful accounts. There is the existence of contra accounts in accounting which are accounts that have the purpose of decreasing the value of another specific account if the two accounts are netted or summed together. 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. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance.

They are used in case some customers won’t be able to pay the money they owe to the business. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. Contra liability accounts are special accounts in the liabilities section of the balance sheet. This would let users of the financial statements calculate the book value of the liability. In the realm of accounting, various techniques are used to ensure financial statements provide an accurate and comprehensive view of a company’s financial health.

These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset.

As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records. Are you looking for a way to account for accumulated depreciation, returned merchandise, or damaged inventory? You can use contra accounts to record the goods your customers return, inventory that gets damaged, and equipment depreciation. Each of these contra accounts serves to provide more detailed information about the transaction history of the related main account.

• The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.
• 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.
• The term “contra” means “against,” which perfectly describes the role these accounts play in your finances – they are going against the norm.
• A contra account is a negative account that is netted from the balance of another account on the balance sheet.

The sales discounts contra revenue account records the discounts given to customers on sales made to them, normally a cash or settlement discount. The account is normally a debit balance and in use is offset against the revenue account which is normally a credit balance. Consequently the net balance of the two accounts shows the net value of the sales after discounts. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts.

What is a contra account?

A company creates allowances for doubtful accounts to record the portion of accounts receivable which it believes it will no longer be able to collect. The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet. In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.” The sales discounts account contains the amount of sales discounts given to customers, which is usually a discount given in exchange for early payments by them.

• 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.
• Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.
• Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts.
• The company predicts which accounts receivable won’t be paid by customers and writes those off.

If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements. 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. 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.

What is a Contra Liability?

Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position. This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the current and historical book values for a particular asset or liability. Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense.

How to Record a Contra Account

Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts. the difference between cash flow and profit The dollar balance in the allowance for uncollectible accounts is the amount you don’t expect to collect, and this offsets the amount you report in accounts receivable. Contra accounts allow you to show the amounts that offset a paired related account.

Contra Equity Account

The monthly accounting close process for a nonprofit organization involves a series of steps to ensure accurate and up-to-date financial records. The concepts of debits and credits in accounting dictate how transactions are recorded. 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. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.

For example, when you debit the balance in sales returns account, make sure that you offset the sales revenue account with a credit balance. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount of depreciation attributed to that equipment, and the remaining useful life.

By tracking contra accounts, a company can make more informed decisions about asset management, liability settlement, and overall financial planning. A contra account is an account with a balance opposite the normal accounts in its category. Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts. In other words, contra accounts are used to reduce normal accounts on the balance sheet.

Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. Contra accounts help maintain the accuracy of financial records, provide transparency in reporting, and allow for proper tracking and analysis of specific transactions or events. Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers.

At this point, it isn’t known which accounts will become uncollectible so the Accounts Receivable balance isn’t adjusted. Instead, an adjusting journal entry is done to record the estimated amount of bad debt. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings.