Are you looking for a way to account for accumulated depreciation, returned merchandise, or damaged inventory? You can use contra accounts to record the goods your customers return, inventory that gets damaged, and equipment depreciation.
Contra accounts allow you to show the amounts that offset a paired related account. As a small business owner, understanding how to set up contra accounts enables you to prepare and maintain accurate financial records.
What Is a Contra Account?
A contra account is a general ledger account that offsets the balance of a corresponding account with which it’s paired. If you debit the contra account, ensure that you offset the related account with a credit balance. In essence, contra accounts allow you to report your firm’s gross and net amounts. These accounts also ensure that you follow the matching principle in accounting, which states that you record expenses in the same period you incur them.
Examples of Contra Accounts
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.
What is a contra asset?
A contra asset shows a zero or negative balance on your company’s balance sheet. This type of listing offsets the balance in the asset account associated with the contra asset, thereby reducing an asset’s overall value.
A normal asset has a debit balance, while a contra asset sits against this to show the net balance of both assets on your financial statement. In some sense, you can consider a contra asset as a negative asset.
The reason you show a contra asset on a balance sheet is so you can see the overall net balance of a particular asset and to give investors a more accurate look into your company’s financial activity.
Accumulated Depreciation as a Contra Asset
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.
For example, if you bought a car for $10,000 seven years ago and you estimated a seven-year life on the vehicle. Now, the car is worth less than $1,000 and you continue to put more money into upkeep, maintenance, and insurance for the car than the value of the vehicle.
Although the car is normally an asset because you can sell it for parts or use it for your business, when the car depreciates to a zero or negative balance, it is a contra asset on your balance sheet.
Contra asset accounts
Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts. The dollar balance in the allowance for uncollectible accounts is the amount you don’t expect to collect, and this offsets the amount you report in accounts receivable.
If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements.
Contra liability accounts
Given that liabilities have a credit balance, ensure that all your contra liabilities accounts have debit balances. Discount on notes payable and discount on bonds are examples of contra liability accounts.
Contra revenue accounts
Examples of a contra revenue accounts include sales returns, sales discounts, and sales allowances. You debit the contra revenue accounts and credit the corresponding revenue accounts. For example, when you debit the balance in sales returns account, make sure that you offset the sales revenue account with a credit balance.
Contra equity account
With contra equity accounts, you reduce the number of outstanding shares you list on your company’s balance sheet. Treasury stock and owner’s drawing account are examples of contra equity accounts.
Doubtful Debts and Contra Assets
A doubtful 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.
For example, if your business has accounts receivable of $50,000 and an allowance for doubtful debts account totalling $5,000, the net accounts receivable is $45,000. In this way, a contra asset (credit) lowers the overall value of your accounts receivables (debit) on the balance sheet.
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.
Illustrating Contra Accounts
If the balance in your allowance for doubtful accounts has a credit of $1,000 and your accounts receivable has $20,000 in normal debit balance, then the net value of the receivables is $19,000.
The contra asset account, which is allowance for doubtful accounts, indicates the original (gross) amount you report in the accounts receivable. It also shows the carrying (net) amount of $19,000, which you report to your firm’s balance sheet.
In a sales returns and allowances contra revenue account, you offset the balance in the sales revenue account. When the contra account reads $500 and the normal credit balance is $100,000, then your net sales are $99,500. This indicates that out of $100,000 sales, your customers return goods valued at $500.
The contra asset account of your equipment account is the accumulated depreciation of equipment. When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000.
How to Present Contra Accounts on Financial Statements
Make sure that you report contra accounts on the same financial statement as the related accounts. If you’re the one managing your company’s books of accounts, be sure to report the contra account on your financial statement on the line item directly beneath the main account.
For example, when a line item on your balance sheet presents the balance of accounts receivable, report the value of allowance of uncollectible accounts below the accounts receivable line. Be sure to enter the contra account on the opposite column of the account they’re offsetting. If contra assets appear in the credit column, record contra liabilities on side.
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). Enter the type of contra account when prompted and give it a name such as “Allowance for Spoilage and Blemished Items.” Ensure that you create the same type as the paired account and always apply credits to asset accounts and debits to liability accounts.