Contra Accounts: Definition, Meaning, Examples, Types, Importance

This loss is treated as an ordinary business expense and is deducted from the asset’s balance. A contra account relates to a specific area in the balance sheet that includes a negative balance. Companies record the opposite entries for that area in the related contra account. Consequently, these accounts offset the balances related to the original account.

On the other hand, when a utility customer pays a bill or the utility corrects an overcharge, the customer’s account is credited. If the credit is due to a bill payment, then the utility will add the money to its own cash account, which is a debit because the account is another Asset.

Definition of Contra Asset Account

Notes PayableNotes Payable is a promissory note that records the borrower’s written promise to the lender for paying up a certain amount, with interest, by a specified date. BondsBonds refer to the debt instruments issued by governments or corporations contra asset account definition to acquire investors’ funds for a certain period. 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.

By doing so, they can bring their asset accounts to a more accurate position. A contra account is an account that companies use to reduce the value of a related account. It usually nets off against related accounts and provides an opposite effect to the balance. Therefore, contra accounts are the reverse accounts that decrease a specific account’s balance. The above accounts are the standard items that a company’s financial statements will include. However, there are other items as well that may not show in those financial statements. The “Accumulated Depreciation” line item is the contra asset account reflected on the balance sheet, but often they are combined as “PP&E, net”.

The Net Method of Accounting for Sales Discounts

The amount spent on their purchase is capitalized and treated as assets. The cost is amortized every year until the asset is expected to be used. Contra asset accounts are prepared so that a specific reverse effect on the corresponding asset could be recorded. Allowance for doubtful debts accumulates the bad debt expense that has been provided so far. A bond discount is an example of a contra liability account and it reduces the amount of a bond payable.

Another example of an accounting error leading to a credit balance on an asset account would be if you continued to depreciate an asset after its value has already gone to zero. It’s ok to have a credit balance in an accumulated depreciation asset account, but the net value of an asset should never go below zero.

Purpose of Adjusting Entries in a General Ledger

When an amount is accounted for on its normal balance side, it increases that account. On the contrary, when an amount is accounted for on the opposite side of its normal balance, it decreases that amount. For example, when making a transaction at a bank, a user depositing a $100 check would be crediting, or increasing, the balance in the account. Any 12-month period used for financial reporting of a company’s annual operations ending on a date other than December 31st. They are used to keep track of the historical cost of assets instead of reducing the value of an asset. Another example of a contra account is a discount allowed account, which is the contra account to revenue account.

The sales discount account represents the discount amount a company gives to customers as an incentive to purchase its products or services. These https://online-accounting.net/ items decrease the liability balance on the paired liability account. For example, a discount on bonds is a type of contra liability account.

Discount on Notes Receivable

Personal accounts are liabilities and owners’ equity and represent people and entities that have invested in the business. Accountants close out accounts at the end of each accounting period. This method is used in the United Kingdom, where it is simply known as the Traditional approach.

Here’s a short list of some example contra asset accounts and their corresponding asset accounts. Contra accounts are crucial in reducing the balance on the paired account. However, contra accounts allow them to track these transactions separately. Furthermore, these accounts are also crucial in allowing companies to record the original values for the paired accounts. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account.

From the bank’s point of view, when a credit card is used to pay a merchant, the payment causes an increase in the amount of money the bank is owed by the cardholder. From the bank’s point of view, your credit card account is the bank’s asset. Hence, using a debit card or credit card causes a debit to the cardholder’s account in either situation when viewed from the bank’s perspective. When bad debts are incurred, the allowance for doubtful debts would decrease and the accounts receivable would be reduced by that amount.

The natural balance in a contra asset account is a credit balance, as opposed to the natural debit balance in all other asset accounts. There is no reason for there to ever be a debit balance in a contra asset account; thus, a debit balance probably indicates an incorrect accounting entry. When a contra asset transaction is created, the offset is a charge to the income statement, which reduces profits. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts reduce accounts receivable, while accumulated deprecation is used to reduce the value of a fixed asset.

Whether a debit increases or decreases an account’s net balance depends on what kind of account it is. The basic principle is that the account receiving benefit is debited, while the account giving benefit is credited. Contra asset accounts also provide a clear picture of the companies’ accumulation of assets. Similarly, these accounts can also be essential in various calculations. As mentioned, companies do not represent these accounts on the balance sheet. However, they will still appear on the notes to the financial statements with necessary disclosures.

• If a ledger were to be observed in this situation, then one would see a balance of three asset debits matched up against three contra asset credits .
• This account helps companies present a more accurate accounts receivable balance on the financial statements.
• In this lesson, compare and contrast these types of expenditures, including examples of each and how they are considered on a balance sheet.
• Before you issue a balance sheet, fix any errors and reclassified any asset accounts with a credit balance as a liability.
• Allowance for doubtful accounts offsets a company’s accounts receivable account.

There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Liability accounts record debts or future obligations a business or entity owes to others.