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Contra Account

Guide to Understanding Contra Accounts

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Contra Account

Contra Account Definition in Accounting

Debit-Credit Journal Entry

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:

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.

Example Contra Account – 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

Suppose a company has recorded $100,000 in accounts receivable (A/R) and $10,000 in the allowance for doubtful accounts (i.e. 10% of A/R is estimated as uncollectible).
 Journal Entry Debit Credit
Accounts Receivable Account $100,000
Allowance for Doubtful Accounts $10,000

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

Types of Contra Accounts

Contra Asset, Contra Liability and Contra Equity

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

Contra Asset
  • A contra asset is an asset that carries a credit balance rather than a debit balance.
  • While technically classified as an asset, it functions closer to a liability as it reduces the value of the asset it is paired with.
Contra Liability
  • A contra liability is a liability account that carries a debit balance as opposed to a credit balance.
  • Despite being classified as a liability, it functions more like an asset because benefits are provided to the company.
Contra Equity
  • A contra equity account has a debit balance instead of a credit.
  • The contra equity account reduces the total amount of shareholders’ equity.

Contra Account Examples

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

Contra Asset
  • Depreciation is an example of a contra asset because it reduces the carrying balance of property, plant & equipment (PP&E) while providing tax benefits since depreciation reduces pre-tax income.
  • The “Accumulated Depreciation” line item is the contra asset account reflected on the balance sheet, but often they are combined as “PP&E, net”.
Contra Liability
  • Financing fees in M&A are an example of a contra liability, as the fees are amortized over the debt’s maturity – which in turn reduces the tax burden (and results in tax savings) until the end of the term.
  • Another type of contra liability is an original issue discount (OID), which shares many similarities as financing fees in terms of accounting treatment (i.e. amortized across borrowing term, reduces pre-tax income) and the two are often consolidated.
Contra Equity
  • An example of a contra equity account would be treasury stock, the amount paid to repurchase previous issuances of stock, which reduces shareholders equity and the total number of shares outstanding.
  • Since treasury stock reduces the total shareholders’ equity amount, treasury stock is entered as a negative value on the balance sheet (i.e. with a negative sign in front)

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.
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