Setting up a contra account is an easy way to show amounts that offset a paired related account. For example, you may want to set up an account that offsets inventory to reflect the value of damaged or blemished goods, or an account to show offsets against accounts receivable to reflect an allowance for bad or forgiven debts. Two things to remember are a contra account must always be paired with a related account, and entries to contra accounts should be shown as credits to a paired asset account or debits to a paired liability account. When preparing financial statements, show the contra below its paired account to reflect the net result of the two like with this example:
Allowance for Spoilage or Blemished Goods (350,000)
Net Inventory –
In this example, the primary account is an asset account for inventory that’s specified as produce. You can get more specific by naming it Inventory — Produce — Peaches, and set up a contra account the same way to indicate offsets. The Inventory account reflects the amount paid for the produce as well as any expenses involved in obtaining the item such as delivery fees, import duties and other related acquisition costs. The contra account reflects the allowance for spoiled or blemished items that are expected to occur. Notice how setting up the contra account in this manner shows the actual value of the produce account. The contra account should always show the deductions from its paired account to reflect the true value of the listed asset and ideally give an indication why the net value differs from the original value.
Most accounting software packages make it easy to set up contra accounts. Intuit’s Small Business Center shows you how easy it is to do this in [Quicken]. Simply hit Control + N under the Chart of Accounts or Edit, then New (to create a new account), enter the type as “Inventory – Produce” when prompted and give it a name such as “Allowance for Spoilage and Blemished Items.” You can set up contra accounts for equity, revenue, and liability the same way. Just remember to create the same type as the paired account and to always apply credits to asset accounts and debits to liability accounts.