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What Is A Contra Account
What Is A Contra Account
KEY TAKEAWAYS
This type of account could be called the allowance for doubtful accounts
or bad debt reserve. The balance in the allowance for doubtful accounts
represents the dollar amount of the current accounts receivable balance that
is expected to be uncollectible.1 The amount is reported on the balance
sheet in the asset section immediately below accounts receivable. The net of
these two figures is typically reported on a third line.
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.
The third contra type is contra equity. These contras reduce the equity
account and carry a debit balance. 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.2
Now, for contra revenue accounts there are sales discounts, sales
allowances, or sales returns. Contra revenue reduced gross revenue,
resulting in net revenue. These contra revenue accounts tend to have a debit
balance.2
How to Record a Contra Account
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 as a debit to increase bad debt
expense.
When accounting for assets, the difference between the asset's account
balance and the contra account balance is referred to as the book value.
There are two major methods of determining what should be booked into a
contra account.
In order to balance the journal entry, a debit will be made to the bad debt
expense for $4,000. Although the accounts receivable is not due in
September, the company still has to report credit losses of $4,000 as bad
debts expense in its income statement for the month. If accounts receivable
is $40,000 and allowance for doubtful accounts is $4,000, the net book value
reported on the balance sheet will be $36,000.
Those who are struggling with recording contra accounts may benefit from
utilizing some of the best accounting software currently available.
Fast Fact
The difference between an asset's account balance and the contra account
balance is known as the book value.
Example of a Contra Account
A major example of a contra account is the accumulated depreciation. Again,
accumulated depreciation reduced fixed and capital asset balances. Apple
breaks out its amount of property, plant, and equipment (PP&E) and then lists
its accumulated deprecation that reduces the PP&E figure.
For fiscal year 2021, Apple's gross PP&E (which includes land, buildings,
machinery, etc.) came in at $109.7 billion. Meanwhile, its accumulated
depreciation and amortization figure comes in at $70.3 billion.5 Here's how
Apple break it down in their annual report: