Accumulated depreciation tallies the depreciation to date of a fixed asset, such as a car or a building. Examples of contra accounts include allowance for doubtful accounts, reserve for obsolete inventory, and accrued liabilities. Each of these accounts helps to offset another account on the balance sheet.
The contra liability account is used to adjust the book value of an asset or liability. When recording an entry into the contra liability account, the typical entry rules are reversed; adding to the contra account is a debit, whereas an addition to the liability account is typically a credit. The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s basics of lifo and fifo inventory accounting methods balance sheet. 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. When a listed company buys back its own shares from the open market, it records the transaction by debiting the treasury stock account.
- Any entry made to contra accounts is presented on a company’s balance sheet under the paired account.
- 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.
- Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented.
- Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts.
The B/S impact is where the contra liability comes into play, i.e. the historical value of the debt is not impacted by the OID. Discount on sales account represents the discount amount a company gives to customers as an incentive to purchase its products or services. Providing sales allowance represents discounts given to customers to entice them to keep products instead of returning them. Both ways of accounting will have the same impact but the later one will give you more information such as purchases cost of machinery; how much depreciation is written off etc. 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.
Expense Contra Account
A contra account is an account used in a general ledger to reduce the value of a related account when the two are netted together. The term “contra” means “against,” which perfectly describes the role these accounts play in your finances – they are going against the norm. The purpose of the Sales Returns account is to track the reduction in the value of the revenue while preserving the original amount of sales revenue. The purpose of the Owner’s Withdrawal account is to track the amounts taken out of the business without impacting the balance of the original equity account. The purpose of the Accumulated Depreciation account is to track the reduction in the value of the asset while preserving the historical cost of the asset.
Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. 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. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation.
How to Record a Contra Account
The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.
Gain on Debt Reduction
The company uses Straight-Line Depreciation to track the loss of value of the asset over time. Most often in such situations the amount of loan payable is reduced directly from loan payable account & a profit is shown on the Income statement of the business. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. In spite of its name, contra liabilities function more similarly to assets. Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective”), an SEC-registered investment adviser.
Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural 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 contra asset account of your equipment account is the accumulated depreciation of equipment.
Types of Contra Accounts
A contra account is used to show the opposite effect or reduction of a related account. When the company pays the cost of having the flyer printed, a journal entry is done. A delivery van is purchased by a business to use in delivering product and picking up materials.
While there is nothing wrong here, there is also another way you could represent it i.e. show the full value of machinery (cost) in the balance sheet and then reduce the depreciation amount. Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. If the company repays the loan early, the lender may provide a discount. This discount is subtracted from the total amount borrowed to better reflect the discount given by the lender. 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.
A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts.
The sales allowance shows the discounts given to customers when returning the product. This is done to entice customers to keep products instead of returning them. The percentage of sales method assumes that a fixed percentage of goods or services sold by a company cannot be received. In other words, accumulated depreciation will be $10,000 each year until the car depreciates to $0 twenty years later.
BREAKING DOWN Contra Liability Account
Each year of an asset’s life, another year of Depreciation Expense is recorded. The offset to the Depreciation Expense account is Accumulated Depreciation. This means that accounts receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. 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.