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For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100.
Contra Liability Example – Original Issue Discount (OID)
Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. The reason financing fees are an example of a contra liability is that the fees – much like interest on the debt – are amortized over the debt borrowing term.
This allows the reader to see both the current and historical book values for a particular asset or liability. Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement. Contra liability accounts are not used as often as contra asset accounts. Contra asset accounts affect items such as inventory, which is adjusted in value more frequently than bonds or other fixed income securities that are considered liabilities.
The first contra liability listed is an original issue discount (OID), a feature of debt financing wherein the issuance price is less than the redemption price. An item on one side of an account which offsets fully or in part on the opposite side of the same account is technically referred to as contra account. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account.
- Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account.
- One of the few examples of a contra liability account is the discount on bonds payable (or notes payable) account.
- A contra-liability account is a liability account in which the balance is expected to be a debit balance.
- For example, a grocery store displays advertisements for a national brand in its weekly flyer.
- Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares.
Contra account is important as it not only allows a company to report the original amount of a transaction but also report any reductions that may have happened so that the net amount will also be reported. They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value. Contra accounts serve an invaluable function in financial reporting that enhances transparency in accounting books. Each of these contra accounts serves to provide more detailed information about the transaction history of the related main account. By tracking contra accounts, a company can make more informed decisions about asset management, liability settlement, and overall financial planning.
The accumulated depreciation amount shows how much depreciation expense has been charged against an asset. Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet.
Examples include accumulated depreciation, sales returns and allowances, and contra equity accounts like treasury stock. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances. Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets. In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed.
The difference between an asset’s account balance and the contra account balance is known as the book value. 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. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. In terms of the journal entries, the debit balance in “Discount on Bonds Payable” is subtracted from the credit balance in the “Bonds Payable”. The reason for recognizing a contra liability is to reduce the corresponding account for amounts that cannot be realized or collected, while not adjusting the historical cost. Notes payable or bills payable represents a liability created when a company signs a written agreement to borrow a specific amount of money.
List of Contra Accounts
One of the few examples of a contra liability account is the discount on bonds payable (or notes payable) account. 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. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset. Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. 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 Contra Accounts
If the balance in your allowance for doubtful accounts has a credit of $1,000 and your accounts receivable has $20,000 in normal debit balance, then the net value of the receivables is $19,000. Showing contra assets on your balance sheet allows potential investors to see how you write-down a depreciable asset, such as a piece of equipment. Contra assets give investors a better picture of how you use your assets over time. A doubtful debts contra account allows for future write-offs of accounts receivable.
Is a Contra Account a Debit or Credit?
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. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling. 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.
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.
Why should one include contra accounts on a balance sheet?
They serve an invaluable function in financial reporting that enhances transparency in accounting books. 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. The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company.
Only by using this account, you can offset the respective asset account that it is paired in the balance sheet. In the above example, accumulated depreciation is a contra account of machinery. For example, if your business has accounts receivable of $50,000 and an allowance for doubtful debts account totalling subcontractor billing requirement $5,000, the net accounts receivable is $45,000. In this way, a contra asset (credit) lowers the overall value of your accounts receivables (debit) on the balance sheet. 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.