You can use contra accounts to record the goods your customers return, inventory that gets damaged, and equipment depreciation. When looking at the balance sheet, it is essential to understand what is being shown on the two sides – the assets debit balance and the liabilities credit balance. The assets are always shown on the left-hand side, and the liabilities are always displayed on the right-hand side.
The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. 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. The sales discounts contra revenue account records the discounts given to customers on sales made to them, normally a cash or settlement discount.
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 contra revenue account reporting that enhances transparency in accounting books. Contra accounts allow you to show the amounts that offset a paired related account. As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
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. The hottest retail item of today can be relegated to nostalgia channels on YouTube tomorrow. And when your business still has some of these outdated, unwanted, or unusable items in your inventory, you’ll want to offset the lost value of these assets in your general ledger and balance sheet. So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory. There is almost always a story behind data; a clarification or historical insight that changes the meaning behind raw figures. In a report, layering on that additional context can be easy, but in a general ledger, you have few options for conveying nuance and subtlety.
Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance. Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. For example, if your business has accounts receivable of $50,000 and an allowance for doubtful debts account totalling $5,000, the net accounts receivable is $45,000.
The sales will still show a sales credit on the profit and loss of 90,000, but there is also a contra returns account with a debit of 2,500. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. In other words, contra revenue is a deduction from gross revenue, which results in net revenue. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
You may want to first classify contra accounts as contra asset accounts, contra liability accounts, contra equity accounts, or contra revenue accounts before accounting for any transaction. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. 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.
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. The amount on the equity contra account is deducted from the value of the total number of outstanding shares listed on a company’s balance sheet.