What is a contra account? Everything you need to know

The contra account can be a tricky concept to wrap your head around, especially if you’re among the 54% of small business owners who say they didn't have a strong understanding of financial management before starting a business. But understanding how they work is necessary if you want to keep your financial statements accurate.

Here’s what you need to know about contra accounts and the role they play in your financial reporting. We’ll explore what they are, which ones you’ll probably use, and how to set them up in your bookkeeping software.

Jump to:

• Understanding contra accounts
• Common examples of contra accounts for small businesses
• How to set up and present contra accounts on financial statements
• Why contra accounts matter for your small business
• Streamline your accounting and save time

Understanding contra accounts

A contra account is a type of general ledger account you use to offset another, like an asset or revenue account. In other words, it tracks reductions against a paired account, helping you break out gross and net amounts in your financial records.

Contra accounts also help you follow important accounting tenets, like the matching principle, which says you need to record expenses in the same period you recognize related revenues.

For example, asset accounts normally carry a debit balance. As a result, their contra accounts also appear as assets in the general ledger, but they accumulate a credit balance. When you put them together, they offset to reveal the net value of the asset.

Common examples of contra accounts for small businesses

Let’s explore some of the contra accounts you’ll probably use in your day-to-day bookkeeping.

Contra asset accounts

Contra-asset accounts reduce the value of a paired asset account. Like we mentioned above, normal asset accounts have a debit balance, while contra-asset accounts carry a credit balance.

Here are some of the most common contra-asset accounts:

• Accumulated depreciation: This contra account represents the total depreciation to date of a fixed asset, such as a building or piece of equipment. By netting it against the asset’s cost basis, you reveal the asset’s book value. For example, the book value of a car that costs $5,000 and has $3,000 of accumulated depreciation is $2,000.
• Allowance for doubtful accounts: This represents the portion of accounts receivable (AR) you expect to be uncollectible. By subtracting it from AR, you calculate your Net Receivables. For example, if your AR is $10,000 and your Allowance for Doubtful Accounts is $3,000, your Net Receivables are $7,000.
• Slow-moving and obsolete inventory: This represents the portion of your inventory that’s no longer sellable, typically because it’s outdated or damaged. For example, if you have $15,000 worth of goods in your inventory, but $5,000 is obsolete, your net inventory value is $10,000.

Contra liability accounts

Contra-liability accounts lower the balance of a paired liability account. Liabilities normally carry a credit balance, so contra liabilities typically have a debit balance. 

The most common contra liability is a discount on notes payable and bonds payable. When you issue a note or bond at a price below its face value, use this contra account to reduce the carrying value of your liability.

For example, say you issue a $100,000 note for $97,000 because the note’s interest rate is below the market rate. You’d credit Notes Payable for $100,000, debit Cash for $97,000, and debit your Discount on Notes Payable (the contra liability) for $3,000. Your net Notes Payable balance would be $97,000. 

Contra equity accounts

Contra-equity accounts reduce your total equity. Since equity accounts normally carry a credit balance, contra-equity accounts have a debit balance. 

Here are some of the most common contra equities:

• Treasury stock: These are shares of company stock you’ve repurchased from the open market, reducing the number of outstanding shares. For example, say you’ve issued $10,000 of common stock to date. If you repurchased shares worth $3,000, you’d credit cash for $3,000 and debit treasury stock for $3,000, reducing total shareholders’ equity to $7,000.
• Owner's drawing account: This is the amount of money or assets a business owner has withdrawn from their sole proprietorship or partnership for personal use, reducing owner’s equity. For example, say you’ve accumulated $50,000 in owner’s equity. If you withdraw $5,000 from your partnership to fund improvements to a personal residence, you’d credit cash for $5,000 and debit your owner’s drawing account for $5,000, reducing owner’s equity to $45,000.

Contra revenue accounts

Lastly, what is contra revenue? These accounts offset gross revenue, helping you break out net revenue on the income statement. Since normal revenues have a credit balance, contra revenues carry a debit balance.

The most common examples include:

• Sales returns and allowances: This represents the value of the refunds you’ve issued for products that customers have returned or claimed were defective. For example, if your gross sales for the year were $200,000, but you had $25,000 in sales returns and Allowances, your net sales would be $175,000.
• Sales discounts: This represents the value of any price reductions you’ve given to customers, such as for early payment of invoices. For example, if you offer 2/10 net 30 terms—a 2% discount for paying within 10 days—on a $10,000 invoice and your customer pays in the first week, you’d record a $9,800 debit to cash, a $10,000 credit to gross sales, and a $200 debit to sales discounts. Your net sales would be $9,800.

How to set up and present contra accounts on financial statements

Here’s how to add contra accounts to your general ledger and make sure they appear correctly on your financial statements.

Setting up contra accounts in accounting software

Fortunately, modern accounting software, like QuickBooks Online, makes setting up contra accounts pretty intuitive. Here’s how you do it:

• Open the chart of accounts (COA): This digital document is a numbered list of all the accounts in your general ledger, including assets, liabilities, revenue, expenses, and equities.
• Create a new contra account: Add a new entry in the COA for your contra account, making sure to select the same type of account as the one you want to offset.
• Add initial account details: Give your contra account a name, number, and beginning balance, if applicable. Consider assigning a number that places it next to its paired account in the COA. For example, if Inventory is 1300, you might make Slow-Moving and Obsolete Inventory 1301.

Presenting contra accounts on financial statements

Contra accounts always show up on the same financial statement as their paired account, typically right below. This makes it easy for users to see that they offset each other.

Here’s how you might show contra accounts on the balance sheet:

Here’s how they might appear on the income statement.

Why contra accounts matter for your small business

Let’s explore the role contra accounts play in financial management.

Providing a clear financial picture

Contra accounts help make your financial records clearer. More specifically, they let you break out the gross and net values of your accounts, as well as the reductions offsetting them.

In addition to simplifying the bookkeeping process, this gives stakeholders and other financial statement users a more complete understanding of assets, liabilities, equities, and revenues.

Adhering to accounting principles

In addition to boosting transparency, contra accounts help you follow fundamental accounting principles. They’re most closely connected to the matching and historical cost principles.

The matching principle says you need to deduct expenses in the same period you earn related revenues. Meanwhile, the historical cost principle says you should report assets on the balance sheet at their original purchase price, not their current market value.

For example, posting to the Accumulated Depreciation account is how you spread the cost of an asset over its useful life—the period in which you expect it to contribute to your revenue. At the same time, it allows you to keep the historical cost of the asset on your balance sheet, with the reduction in its book value shown separately through the contra account.

Improving decision-making

Contra accounts aren’t just for external stakeholders. They can also help you make better informed business decisions, especially regarding pricing, inventory management, credit issuance, and asset utilization.

For example, tracking the Allowance for Doubtful Accounts helps you monitor how often invoices are becoming uncollectible. If the frequency gets too high, you may decide to tighten your credit policies.

Similarly, breaking out Sales Returns and Allowances lets you track how often customers are requesting refunds. If it spikes after you open a new product line, you might figure out that the quality isn’t living up to customer expectations for the price, empowering you to take action.

Streamline your accounting and save time

Contra accounts help you track reductions to normal asset, liability, equity, or revenue accounts. Not only do they make your financial records more transparent, but they also help you follow accounting principles and make better-informed decisions.

QuickBooks accounting software makes it easy to break out contra accounts and organize your financial statements. With automated reporting and a user-friendly dashboard, you can spend less time on bookkeeping and more time growing your business.