Contra Liability Account: What it is, How it Works, Example

When researching companies, the financial statement is a great place to start. Home Depot also devotes footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. Contra accounts help provide more accurate financial information by separating certain items contra expense account and highlighting their impact on the overall financial position. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Master accounting topics that pose a particular challenge to finance professionals. The OID is calculated as the difference between the redemption price and the discounted issuance price.

How to Record a Contra Account

That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. 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 (which is contrary to the debit balances found in asset accounts). The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. 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.

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By understanding the nature and function of contra accounts, businesses can accurately reflect their financial position, providing transparency to stakeholders such as investors, creditors, and internal management. As your business acquires new assets (e.g., machinery, office equipment, vehicles), you record the initial purchase value in your Fixed Asset account. But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss. In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account.

Contra revenue account

• The accumulated depreciation account is designed to reduce the carrying value of the fixed asset account when depreciation is recorded at the end of each period.
• If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries.
• The net amount is often referred to as the carrying amount or perhaps the net realizable amount.
• A contra asset account is an account in the balance sheet that offsets the balance of a regular asset account.

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. The purpose of a contra expense account is to record a reduction in an expense without changing the balance in the main account.

Contra asset accounts have a balance that is opposite from the regular asset accounts. In other words, a contra asset account maintains a credit balance instead of a debit balance. In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account.

In this article, we’re going on a deep dive into what exactly a contra account is, how contra accounts work, why and how you would use contra accounts and more. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. 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. Get instant access to video lessons taught by experienced investment bankers.

• This means that entries recorded on the left side of the T-account will increase the asset balance and entries recorded on the right side will decrease it.
• Contra accounts are an essential component of the accounting process, designed to reflect the true value of assets, liabilities, equity, or revenue of a business.
• Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance.
• Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance.
• The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement.

What is a Contra Revenue Account?

This balance is used to offset the value of the asset being depreciated, so as of September 1, your $8,000 asset now has a book value of $7,866.67. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Anytime you need to depreciate an asset, you’ll use an accumulated depreciation contra asset account, which records the amount of depreciation that has been expensed while offsetting the value of the asset being depreciated. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount.

• Accumulated Depreciation acts as a subaccount for tracking the ongoing depreciation of an asset.
• In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount.
• To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together.
• You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity.

All of this information is reported on the balance sheet so that it is easier for the readers to understand the financial position of the company. This account serves two purposes — tracking total depreciation expenses while providing you with the accurate book value of the asset being depreciated. The purpose of the Owner’s Withdrawal account is to track the amounts taken out of the business without impacting the balance of the original equity account.

The offset to the Depreciation Expense account is Accumulated Depreciation. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. 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.