Contra Account Definition

What Is a Contra Account?

A contra account is utilized in a common ledger to scale back the worth of a associated account when the 2 are netted collectively. A contra account’s pure steadiness is the alternative of the related account. If a debit is the pure steadiness recorded within the associated account, the contra account information a credit score. For instance, the contra account for a hard and fast asset is collected depreciation.

Understanding a Contra Account

Contra accounts are reported on the identical monetary assertion because the related account. For instance, a contra account to accounts receivable, usually known as allowance for uncertain accounts, is a contra asset account.

Any such account could possibly be known as the allowance for uncertain accounts or unhealthy debt reserve. The steadiness within the allowance for uncertain accounts represents the greenback quantity of the present accounts receivable steadiness that’s anticipated to be uncollectible. The quantity is reported on the steadiness sheet within the asset part instantly beneath accounts receivable. The web of those two figures is usually reported on a 3rd line.

Accountants use contra accounts moderately than scale back the worth of the unique account on to hold monetary accounting information clear. If a contra account is just not used, it may be troublesome to find out historic prices, which might make tax preparation harder and time-consuming.

By retaining the unique greenback quantity intact within the authentic account and lowering the determine in a separate account, the monetary data is extra clear for monetary reporting functions. For instance, if a bit of heavy equipment is bought for $10,000, that $10,000 determine is maintained on the final ledger even because the asset’s depreciation is recorded individually.

Sorts of Contra Accounts

There are 4 key kinds of contra accounts—contra asset, contra legal responsibility, contra fairness, and contra income. Contra asset accounts embody allowance for uncertain accounts and collected depreciation. Contra asset accounts are recorded with a credit score steadiness that decreases the steadiness of an asset.

A key instance of contra liabilities embody low cost on notes or bonds payable. Contra liabilities maintain a debit steadiness. Contra legal responsibility accounts should not as common as contra asset accounts.

A legal responsibility that’s recorded as a debit steadiness is used to lower the steadiness of a legal responsibility. The steadiness of a contra legal responsibility account is a debit steadiness. This account decreases the worth of the legal responsibility. Contra Legal responsibility a/c is just not used as regularly as contra asset accounts. It’s not categorised as a legal responsibility because it doesn’t characterize a future obligation.

The third contra sort is contra fairness. These contras scale back the fairness account and carry a debit steadiness. Contra fairness reduces the overall variety of excellent shares on the steadiness sheet. The important thing instance of a contra fairness account is Treasury inventory, which represents the quantity paid to buyback inventory.

Now, for contra income accounts there are gross sales reductions, gross sales allowances, or gross sales returns. Contra income diminished gross income, leading to web income. These contra income accounts are likely to have a debit steadiness.

How you can Document a Contra Account

When a contra asset account is first recorded in a journal entry, the offset is to an expense. For instance, a rise within the type of a credit score to allowance for uncertain accounts can also be recorded as a debit to extend unhealthy debt expense.

When accounting for belongings, the distinction between the asset’s account steadiness and the contra account steadiness is known as the guide worth. There are two main strategies of figuring out what ought to be booked right into a contra account.

The allowance technique of accounting permits an organization to estimate what quantity is cheap to guide into the contra account. The proportion of gross sales technique assumes that the corporate can’t acquire cost for a hard and fast proportion of products or providers that it has bought. Each strategies lead to an adjustment to guide worth.

For instance, an organization has $40,000 value of accounts receivable at September month-end. It estimates 10% of its accounts receivable might be uncollectible and proceeds to create a credit score entry of 10% x $40,000 = $4,000 within the contra account, allowance for uncertain accounts.

To be able to steadiness the journal entry, a debit might be made to the unhealthy debt expense for $4,000. Though the accounts receivable is just not due in September, the corporate nonetheless has to report credit score losses of $4,000 as unhealthy money owed expense in its revenue assertion for the month. If accounts receivable is $40,000 and allowance for uncertain accounts is $4,000, the web guide worth reported on the steadiness sheet might be $36,000.

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Instance of a Contra Account

A significant instance of a contra account is the collected depreciation. Once more, collected depreciation diminished mounted and capital asset balances. Apple breaks out its quantity of property, plant, and tools (PP&E) after which lists its collected deprecation that reduces the PP&E determine.

For fiscal 12 months 2021, Apple’s gross PP&E (which incorporates land, buildings, equipment, and many others.) got here in at $109.7 billion. In the meantime, its collected depreciation and amortization determine is available in at $70.3 billion. Here is how Apple break it down of their annual report:

The Backside Line

Contra accounts are used to scale back the unique account straight, retaining monetary accounting information clear. This permits for the simple dedication of historic prices. That is notably essential for contra asset accounts. The distinction between an asset’s steadiness and the contra account asset steadiness is the guide worth.