However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. 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.
It is essential to practice using contra revenue accounts and contra accounts in working with your bookkeeping because it contributes to the transparency of the company that you are working with. Plus, it helps you to deeply understand how business methods and procedures impact net revenue and your total income. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. Contra accounts play an important role in accounting by helping businesses track certain aspects of their finances more accurately. For example, contra revenue accounts can be used to track the full cost of sales less any discounts or returns.
Therefore, for these three, the debit balance actually represents a negative amount. To illustrate the contra revenue account Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit. It will debit Accounts Receivable for $100,000 and credit to Sales for $100,000. If a customer returns $500 of this merchandise, Company K will debit Sales Returns and Allowances for $500 and will credit Accounts Receivable for $500. Company K’s income statement will report the gross Sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales of $99,500. The main advantage of using separate contra revenue accounts is that each one provides targeted information about the individual deductions taken from sales.
Sales Discounts Account
The difference between an asset’s account balance and the contra account balance is known as the book value. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. The allowance for doubtful accounts – often https://www.kelleysbookkeeping.com/5-key-accounting-assumptions/ called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. 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. All in all, contra accounts are an important tool for businesses to use to understand their financial standing better.
The contra liability account would be used to offset the liability account on the balance sheet. An allowance for doubtful accounts is a contra asset account that is used to offset Accounts Receivable on the balance sheet. This account is used to estimate the amount of money that is not likely to be collected from customers. They are usually subcategory accounts linked to an account on the balance sheet. Contra accounts are used to offset each other and reduce the gross amount. For example, a contra accumulated depreciation account can offset a fixed asset.
The receipt occupies an important place in the classification “bills, invoices, and receipts”. Master accounting topics that pose a particular challenge to finance professionals. 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). For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
What is Contra Account?
If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. 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.
- Lastly, contra revenue account sales allowances can be used for goods that are offered to the customers at a much lesser price because it is somehow damaged or defective.
- 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.
- When a contra asset account is first recorded in a journal entry, the offset is to an expense.
- It is especially important to track sales returns separately and on a trend line, since this can provide important evidence of problems with a company’s products that are causing customers to return goods.
- These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.
- Contra liabilities reduce liability accounts and carry a debit balance.
It is really useful to work with this account because it contains information about the sales value of products that were returned by the buyer. Lastly, contra revenue account sales allowances can be used for goods that are offered to the customers at a much lesser price because it is somehow damaged or defective. In return, the owner is provided with very important data plus essential feedbacks that can contribute to the company’s processes. Contra revenue accounts appear near the top of the income statement, as a deduction from gross revenue.
If the amounts of these line items are minimal, they may be aggregated for reporting purposes into a single contra revenue line item. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. On the other hand, contra revenue account sales discount includes money, volumes, trades, or casual discounts as a way for the stocks to move into a faster rate than the usual ones. It can be used in a lot of business types, and it is offered to those customers who are loyal and committed to the brand itself. Contra revenue account sales returns are very convenient in showing the results on the net revenue of refunds and returns. An example of this can be found in the retail industry where the goods of the company do not meet the expectations of their clients.
Contra Equity Account
The sales discounts account contains the amount of sales discounts given to customers, which is usually a discount given in exchange for early payments by them. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. 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 is used to reduce the net income by the estimated amount of uncollected receivables. This account helps to give a more accurate picture of the company’s financial position. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.
Contra Revenue Account
Accumulated depreciation reflects the reduction in value of a fixed asset. 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 starting a bookkeeping business as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. The company has a contra asset account for accumulated depreciation expense and a separate asset account for equipment cost.
Contra revenue is a deduction from the gross revenue reported by a business, which results in net revenue. These deductions are a common part of doing business, especially if you are trying to retain customers by offering them discounts from the list prices of your goods and services. Contra revenue transactions are recorded in one or more contra revenue accounts, which usually have a debit balance (as opposed to the credit balance in the typical revenue account).