Another description of a contra expense account is an account that reduces or offsets the amounts reported in another general ledger expense account(s). 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 other words, contra revenue is a deduction from gross revenue, which results in net revenue. CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path.
Maximizing Financial Performance with Effective Contra Account Management
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. When a contra asset account is first recorded in a journal entry, the offset is to an expense.
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Such accurate record-keeping is vital for maintaining the integrity of your financial reports. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. 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. In the financial statements the purchases account would be offset against the contra expense accounts to show the net purchases.
Contra Account Definition, Types, and Example
Accurate records prevent overstatement of assets and revenues, thereby aiding in sound decision-making; imagine knowing exactly how much those accounts receivable are truly worth, beyond optimistic estimations. Whereas assets normally have positive debit balances, contra assets, though still reported contra expense account examples along with other assets, have an opposite type of natural balance. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
For the purpose of financial statement reporting, the amount on a contra account is subtracted from its parent account gross balance to present the net balance. Inscrutable Corporation offers long-term disability insurance to its employees under an arrangement in which it pays for the insurance, and then participating employees reimburse it for half of this cost. In the first month of the arrangement, the company pays the insurer $10,000, which Inscrutable records in a long-term disability insurance expense account. It then records $5,000 of contra expense against this account, which is derived from deductions taken from employee pay. Contra expense accounts are rarely used, because organizations find it to be easier to record third-party payments directly against an expense account.
Is a Contra Account a Debit or Credit?
- This depreciation is saved in a contra asset account called accumulated depreciation.
- The account is typically used when a company initially pays for an expense item, and is then reimbursed by a third party for some or all of this initial outlay.
- For example, when a customer’s cheque bounces, a contra account steps in to reconcile the situation financially.
- Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.
- 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.
- Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns.
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