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. A contra revenue account is a revenue account that is expected to have a debit balance (instead of the usual credit balance). In other words, its expected balance is contrary to—or opposite of—the usual credit balance in a revenue account. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. Make sure that you report contra accounts on the same financial statement as the related accounts.
You may use accounting software packages, such as QuickBooks Online to set up contra accounts. Simply hit Control + N under the Chart of Accounts or Edit, then click New (to create a new account). 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. The sales return account is leading to a reduction in the sales account.
- It is important to note that there are different types of contra accounts, each serving a specific purpose.
- 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.
- 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.
For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. 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.
And finally, contra revenue accounts, like sales discounts and allowances, reduce gross revenue to arrive at net revenue. When it comes to recording contra accounts, there are different methods that can be used. For example, when dealing with contra asset accounts, such as accumulated depreciation, the offset is made to an expense account. This allows businesses to accurately reflect the decrease in value of the asset. On the other hand, contra revenue accounts, like sales discounts, are recorded to calculate net revenue.
In the above journal entry, sales returns are the contra-revenue account. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity). The allowance method involves estimating the amount that is likely to be uncollectible and booking it into the contra account. On the other hand, the percentage of sales method assumes a fixed percentage of goods or services sold that the company will not be able to collect payment for. Pilot provides bookkeeping, CFO, and tax services for literally thousands of startups and growing businesses. To talk to an expert on our team and find out what Pilot can do for you, please click „Talk to an Expert” below, or email us at
There are four types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. It is definitely not because it is normally computed on a cash basis. Accounting is documented at the time of payment and time of generation. When a client pays in advance for a service or product, unearned revenue occurs.
In addition, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded https://accounting-services.net/ as a debit to increase bad debt expense. In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance. The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
How to Set up Contra Accounts
Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. It is important to realize that unearned revenue is not a contra revenues account. The balance is held as a current liability (credit) on the balance sheet of the business. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory.
Example of Contra Revenue
Given that liabilities have a credit balance, ensure that all your contra liabilities accounts have debit balances. Discount on notes payable and discount on bonds are examples of contra liability accounts. For example, sales returns and allowances are recorded as a debit to the account and a corresponding credit to accounts receivable.
Time Value of Money
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Contra Account Example: Allowance for Doubtful Accounts
In essence, contra accounts allow you to report your firm’s gross and net amounts. These accounts also ensure that you follow the matching principle in accounting, which states that you record expenses in the same period you incur them. For instance, you buy a car worth $8,00,000 and you will depreciate it by $8,000 per year for the normal wear and tear of the car.
This indicates that out of $100,000 sales, your customers return goods valued at $500. If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements.
In return, the owner is provided with very important data plus essential feedbacks that can contribute to the company’s processes. 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.
By understanding and effectively utilizing contra revenue accounts, businesses can gain valuable insights into their operations, customer satisfaction, pricing strategies, and cash flow management. Contra revenue analysis helps drive informed decision-making, leading to improved profitability, customer relationships, and overall financial performance. Embrace contra revenue as a tool for transparency and analysis, and leverage its insights to guide your business towards sustainable growth and success. Contra revenue accounts, such as sales discounts and allowances, reduce gross revenue, resulting in net revenue.
Therefore, a contra asset can be regarded as a negative asset account. Offsetting the asset account with its respective contra asset account shows the net balance of that asset. A contra account is a general ledger account that offsets the balance of a corresponding account with which it’s paired. If you debit the contra account, ensure that you offset the related account with a credit balance.