Contra Accounts: Definition, Meaning, Examples, Types, Importance

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.

Lockbox Accounts means the accounts maintained by Borrower at the Lockbox Banks into which all collections or payments on their Accounts and other Collateral are paid. Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns. Free Cash Flow The money left over after a company supports operations can be a snapshot of its financial health. Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature. Let’s go over how they work and what the main types are, and then finish with an example. INVESTMENT BANKING RESOURCESLearn the foundation of Investment banking, financial modeling, valuations and more.

A quick definition of contra account:

The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense. For example, when the credit amount in allowance for doubtful accounts increases, it is also recorded in the bad debt expense as a debit increase. Contra accounts appear on the same financial statement as the related account. For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts.

The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. These balances come from an underlying accounting or accumulation of accounts from the financial systems. However, some items may also reduce the total reported amount on these accounts.

Examples of Contra Accounts in a sentence

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. Accumulated depreciation offsets a company’s real property define contra account assets, such as buildings, equipment and machinery. Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

Sales allowances can occur if there is a discount on surplus inventory or a discount because of product defects. In footnote 3, the company reports, „Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.“ Contra LiabilityFinancing fees in M&A are an example of a contra liability, as the fees are amortized over the debt’s maturity – which in turn reduces the tax burden until the end of the term. Suppose a company has recorded $100,000 in accounts receivable (A/R) and $10,000 in the allowance for doubtful accounts (i.e. 10% of A/R is estimated as uncollectible). A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.

What Other Types of Contra Accounts Are Recorded on the Balance Sheet?

Contra Accounts.Any account receivable where Borrower has a corresponding account payable. Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. If the company repays the loan early, the lender may provide a discount.

A contra account relates to a specific area in the balance sheet that includes a negative balance. Companies record the opposite entries for that area in the related contra account. Consequently, these accounts offset the balances related to the original account. Contra accounts link or connect to a paired account which they impact directly. A contra account is an account that reduces the gross valuation of an asset.

Does Issuing Common Stock for the Purchase of a Company Affect Retained Earnings?

If the related account has a debit as the natural balance, then the contra account will record a credit. The purpose of a contra account is to accurately report value of operating performance and assets for a firm. A contra account is an account that records events like adjustments and transactions that are having an opposite effect on a relating account’s true value on the firm’s financial statements. If we record those events within the relating account, we risk losing information that is relevant to analyzing performance. The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period.