What is a contra inventory account?

Without contra-liability accounts, it would be difficult to record and report transactions that affect liability accounts accurately. The use of contra-liability accounts allows for more detailed and accurate financial reporting, which is critical for investors and creditors who rely on a company’s financial statements to make informed decisions. In this example, the contra liability account (Discount on Bonds Payable) is used to provide a more accurate and detailed representation of the company’s liability position. By accounting for the discount on the bonds issued, Green Energy Corp. can track its actual liabilities more effectively and make more informed decisions about its financing strategies. The most common contra equity account is called “treasury stock.” This special account decreases the number of shares outstanding in the market because the company repurchases some of the shares from its buyers. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.

This type of account could be called the allowance for doubtful accounts or a 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. The amount is reported on the balance sheet in the asset section immediately below accounts receivable.

What is a Contra Revenue Account?

The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. Based on the above, there’s a significant difference between contract assets and contract liabilities, not only in an accounting sense but also in a legal sense. The difference between an asset’s account balance and the contra account balance is known as the book value. 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. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet.

They are used in case some customers won’t be able to pay the money they owe to the business. 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. Note that in accounting, the term “book value” is also used interchangeably with net value. Therefore, the book value of an asset in the books is equal to its historical cost (the debit balance of the asset) minus the related amount of contra asset in the balance sheet (the credit balance of the contra asset).

Contra revenue accounts

Showing contra assets on your balance sheet allows potential investors to see how you write-down a depreciable asset, such as a piece of equipment. Contra assets give investors a better picture of how you use your assets over time. A doubtful cash flows debts contra account allows for future write-offs of accounts receivable. Although you have not officially written off these debts yet, you show them to be a negative balance because you don’t believe the customer will pay you.

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). The contra asset account, which is allowance for doubtful accounts, indicates the original (gross) amount you report in the accounts receivable. https://online-accounting.net/ It also shows the carrying (net) amount of $19,000, which you report to your firm’s balance sheet. The two most common contra accounts on a balance are accumulated depreciation and the allowance for doubtful debts. Accumulated depreciation tallies the depreciation to date of a fixed asset, such as a car or a building.

Contra liability account definition

You may want to first classify contra accounts as contra asset accounts, contra liability accounts, contra equity accounts, or contra revenue accounts before accounting for any transaction. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra equity accounts carry a debit balance and reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.

Revenue is an income statement account, but it flows through to the equity section of retained earnings as well. Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement. Contra liability accounts are not used as often as contra asset accounts. Contra asset accounts affect items such as inventory, which is adjusted in value more frequently than bonds or other fixed income securities that are considered liabilities.

How to Record and Report Contra-Liability Accounts on Financial Statements

On the balance sheet, the net liability for the bonds payable will be reported as $980,000 ($1,000,000 – $20,000), reflecting the impact of the discount on bonds payable. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. When either of these parties performs their obligations in terms of the contract, this performance is recorded in the business’s balance sheet as a contract asset or a contract liability. These terms were specifically created in terms of the Accounting Standards Codification (ASC) 606. The debit balances in the above accounts are amortized or allocated to an expense, such as Interest Expense over the life of the bonds or notes payable.

Since this amount is not yet fulfilled by the company (i.e. performance obligation has still not been carried out against this order), it is recorded as a contract liability. Contract Liabilities are also referred to as deferred or unearned revenue. A contract liability is basically an obligation on the part of the entity to transfer goods and services to a given customer for which the entity has already received consideration from the customer. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings.

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In simple terms, contract liability allows the parties to a contract to transfer risk to another. It’s for this reason that these contracts are often referred to as an
indemnity agreement
or
hold harmless agreements
. To understand what contract liability is, it’s important to first unpack the meaning of the separate concepts relating to it. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. The amortization of the financing fees reduces the pre-tax income (EBT) of the company and the company’s tax burden, i.e. the borrower benefits from these tax savings until the bonds reach maturity.

• The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
• Contra liability accounts are not used as often as contra asset accounts.
• On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead.
• This is after the revenue has been ‘earned’ as a result of the delivery of the machines.

The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Seldom used in practice a contra liability account is used for book value adjustments related to an asset or a liability. 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. Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable.

Types of Contra Accounts – Explanation

In accounting, it’s important to properly account for transactions in a balance sheet. Here, a party to a revenue-related contract performs its obligation by either delivering goods to a customer in the case of a business or when making payment in the case of a customer. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. Contra accounts act like regular accounts on the balance sheet but have a unique purpose.