Contra Account Definition
This reduces the amount of the carrying value of a company’s fixed asset to account for the wear and tear over the asset’s useful life. Fixed assets are often listed on the balance sheet as property, plant and equipment. The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. The effect of contra revenue in income statements provides accurate financial information of the company.
Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. 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. The contra revenue account is commonly used in small businesses, especially in some cases wherein you may have items that are needed for refunds or returns. By using a contra revenue account, documenting your transactions will be very easy and convenient.
E.M. Rawes is a professional writer specializing in business, finance, mathematical and social sciences topics. She completed her studies at the University of Maryland, where contra revenue account she earned her Bachelor of Science. During her time working in workforce management and as a financial analyst, she reinforced her business and financial know-how.
Dividends is a debit account, capital accounts are normally credit accounts. For example, there need to be separate accounts to hold the actual cost of property, plant and equipment and related accumulated depreciation. If we record depreciation related adjustments in the cost accounts we will lose key information about the original cost of the assets and accumulated depreciation. To avoid this loss of important data, we record actual cost and depreciation in separate ledger accounts. Contra accounts allow us to report the true value of a organization’s assets.
Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. To illustrate the online bookkeeping Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit. 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. “Sales returns and allowances” is an account on the income statement that is referred to as a contra revenue account — that is, it moves in the opposite direction as revenue.
Businesses use this account when customers return merchandise due to a defective product or any other reason. Purchase returns, allowances and discounts are all examples of contra expense accounts.
Why Do We Have Contra Accounts?
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. 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. 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.
Another example of a contra asset account is the accumulated depreciation account which reduces the reporting value of capital assets. Allowance for obsolete inventory or obsolete inventory reserve are also examples of contra asset accounts. Sales returns is a bookkeeping as the figure is a negative amount net against total sales revenue. It would appear on the company’s income statement in the revenue section. The sales returns contra sales account records the sales value of goods returned by a customer. The net balance of the two accounts shows the net value of the sales made by the business for the accounting period. The contra revenue accounts commonly used in small-business accounting include sales returns, sales allowance and sale discounts.
Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Consulting service or professional services include all income from providing a service to a customer or client. For example, a law firm records professional service revenues when it provides legal services for a client. This transaction records when a customer returns the paid goods, and a refund needs to be given. The transactions made in this account are reported on a company’s financial statements directly under the related account. It is a general ledger account with a purpose to have its balance to be the opposite of the original balance for that account. It is linked to specific accounts and is reported as reductions from these accounts.
- Contra accounts are important because they allow a company to follow the matching principle by recording an expense initially in the contra asset account.
- Unlike other accounts, revenue accounts are rarely debited because revenues or income are usually only generated.
- The balances in contra accounts are reduced when the assets or liabilities with which they are paired are disposed of.
- The contra asset account is later reduced when the expense is recorded.
- Transactions made to contra accounts are presented on a company’s financial statements under the related account.
account is a general ledger account which is planned to have its balance be the opposite of the normal balance for that account classification. Contains the amount of sales discount given to customers, which is usually a discount given in exchange for early payments by customers. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting.
Why Are Contra Accounts Important?
The difference with a cash refund is that instead of making a credit entry to accounts receivable, the company would credit cash by the amount of the purchase. By crediting cash, the company indicates on its balance sheet that its cash is reduced by the amount of the purchase. A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance. Two common contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect. Allowance for doubtful accounts offsets a company’s accounts receivable account.
This account is not classified as an asset since it does not represent a long term value. It is not classified as a liability since it does not constitute a future obligation.
The income statement account Sales Returns and Allowances is a contra revenue account that is associated with the revenue account Sales. If the balance in this contra account is a debit of $3,000 and the Sales account has the expected credit balance of $400,000, the company’s net sales are $397,000. This use of Sales Returns and Allowances enables management to see that its customers had a problem with $3,000 of the company’s goods. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. Since it is a contra asset account, this allowance account must have a credit balance . The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable.
The balance of the contra account will equalizer its parent account while still stabilizing the value of the transactions identified in the relating account. include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. For example, if a company just reported equipment at its net amount, users would not be able to observe the purchase price, the amount contra revenue account 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. Accumulated depreciation is the total amount of depreciation expense allocated to a specific asset since the asset was put into use. It is a contra-asset account – a negative asset account that offsets the balance in the asset account it is normally associated with.
Credit Sales Refunds
Contra accounts are important because they let a company to track the matching principle by recording an expense initially in the contra asset account. However, ledger account it will be meaningless to show the property plant and equipment cost account and the related accumulated depreciation account separately on the balance sheet.
In addition, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. Lastly, https://www.bookstime.com/ 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 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. This can also be applied in the hospitality industry where the services do not satisfy the customer’s needs.
For a clearer understanding of contra revenue account sales allowances and returns, I’m going to explain it by using an illustration. Let us assume that Zawarudo Company sells $100,000 worth of commodities on credit. It will debit accounts receivable for $100,000 and credit sales for $100,000. If a client returns $500 of these commodities, Zawarudo Company will debit sales returns and allowances for $500 and will credit accounts receivable for $500. The Zawarudo Company’s income statement will report the gross sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales. If the customer purchased a product in cash and returns it for a refund, the company would make a debit entry to sales returns and allowances that equals the exact amount of the purchase.
Bad debt expense is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible. Contra accounts are presented on the same financial statement as the associated account, typically appearing directly below it with a third line for the net amount. A contra account is an account used in a general ledger to reduce the value of a related account. Contains either an allowance for reductions in the price of a product that has minor defects, or the actual amount of the allowance attributable to specific sales.
The amount is reported on the balance sheet in the asset section immediately below accounts receivable. This means that a credit in the revenue T-account increases the account balance.
It would appear on the company’s income statement in the revenue section. Then you have your cost of sales or cost of goods sold going on line 2 and when you subtact line 2 from 1c you get line 3 as your gross profit. I have a general understanding of contra revenue vs. cost of sales, but would like to hear from the larger accounting community on the differences between the two. Is contra revenue reported the same as cost of sales or is it netted in revenue? What are some typical (and perhaps non-typical) items reported as contra revenue? The sales allowances account is similar in use to the sales returns account, except that it deals with allowances given against a defective product which the customer has kept and not returned to the business. The company should maintain a separate accounting of contra revenue for a better presentation of financial statements and can estimate the quality of the product.
He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University. When the two balances are offset against each other they show the net balance of both accounts.