Contra Account

How Does a Contra Account Work in Accounting?

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).

The normal balances and impact on the carrying value are as follows:

• Asset → Debit Balance → Increase Asset Value
• Liability → Credit Balance → Increase Liability Value
• Equity → Credit Balance → Increase Equity Value

By contrast, contra accounts have the following balances and impact on an account’s carrying value:

• Contra Asset → Credit Balance → Reduction to Paired Asset
• Contra Liability → Debit Balance → Reduction to Paired Liability
• Contra Equity → Debit Balance → Reduction to Paired Equity

A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.

For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.

On a company’s financial statements, the two items – the contra account and paired account – are often presented on a “net” basis:

• “Accounts Receivable, net”
• “Property, Plant & Equipment, net”
• “Net Revenue”

Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.

The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet.

Contra Account Example: Allowance for Doubtful Accounts

For instance, under U.S. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid).

The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline.

Hence, the “Accounts Receivable, net” line item on the balance sheet adjusts for the allowance to display a more realistic value of A/R and the cash payments to be received, so investors are not misled or caught off guard by sudden decreases in a company’s A/R.

Contra Asset Journal Entry Accounting

Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance.

We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R).

On the balance sheet, the “Accounts Receivable, net” balance would be $90,000.

• Accounts Receivable, net = $100,000 – $10,000 = $90,000

What are the Different Types of Contra Accounts?

There are three distinct contra-accounts, as shown in the table below.

Contra Account Examples

The most common examples of contra-accounts are the following:

• Contra Asset: Accumulated Depreciation, Allowance for Doubtful Accounts
• Contra Liability: Financing Fees, Original Issue Discount (OID)
• Contra Equity: Treasury Stock

Contra Revenue Account

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.

Contra revenue generally carries a debit balance, rather than the credit balance seen in normal revenue.

The most common contra revenue accounts are the following:

• Sales Discounts: The discounts offered to customers, most often as an incentive for customers to make early payments (i.e. to provide more liquidity and cash on hand for the company).
• Sales Returns: The return of a product from a customer, which can either be an “allowance” – similar to the doubtful accounts for A/R – or an actual deduction based on processed returns.
• Sales Allowances. The reduction in the sale price of a product due to quality defects or mistakes, in an effort to encourage the customer to keep a product with minor defects in exchange for the discount.