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A Contra liability account is an account that is used to offset another liability account on the balance sheet. Contra liability accounts are typically used for bonds, notes payable, and other indebtedness. The company can recover the account by reversing the entry above to reinstate the accounts receivable balance and the corresponding allowance for the doubtful account balance. Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases.

• This process will give rise to a contra asset account which is the discount on notes receivables.
• However, these can cause a reduction in other balances on the statement.
• It might be important for a business to track the full cost of sales less contras to see the full picture.
• A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity).
• They are used in case some customers won’t be able to pay the money they owe to the business.

Examples of contra assets include Accumulated Depreciation and Allowance for Doubtful Accounts. Unlike an asset which has a normal debit balance, a contra asset has a normal credit balance because it works opposite of the main account. Contra revenue is a general ledger account with a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances.

Liability Contra Account

If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense. These examples illustrate how contra accounts are used in various contexts to provide a more accurate picture of a company’s financial position and performance. The exact process can vary depending on the specific contra account and the accounting practices of the company.

• In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed.
• By a miracle, it turns out the company ended up being rewarded a portion of their outstanding receivable balance they’d written off as part of the bankruptcy proceedings.
• An example of a contra liability account is the bond discount account, which offsets the bond payable account.
• If you’re using accounting software, you’ll be able to create contra accounts when setting up your chart of accounts.

A similar account can be found in the bookkeeping records if the business sells its products or provides services on a credit. Allowance for doubtful accounts allows management to account for a portion of the debt they assume will be uncollectible in their analysis and business plans. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Contra assets may be stated in separate line items on the balance sheet.

An example of recording a contra asset

Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. Examples include accumulated depreciation, sales returns and allowances, and contra equity accounts like treasury stock.

What is a Contra Liability?

This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time. It can help companies see the complete picture of their income and expenses and their equity or net worth. All in all, contra accounts are an important tool for businesses to use to understand their financial standing better. This question is asked by many students, accountants, and professionals. This article will give you the definition of contra in accounting, talk about different contra accounts, and give examples.

Allowance for doubtful accounts

Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets. It would give a more accurate picture of the company’s fixed assets.

A company uses this account to record how many accounts receivable it thinks will be lost. Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet. This type of account is a contra asset that reduces the amount of the gross accounts receivable account. If the following accounting period results in net sales of $80,000, what is vertical analysis an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. Contra asset accounts represent a realistic picture of your business’s financial health and ensure adherence to accounting standards.

Presentation of Contra Assets

For example, after six years, the asset’s book value on the balance sheet will be $40,000. However, it will also have a negative accumulated depreciation of $60,000, offsetting that cost. However, a contra-asset account usually has a credit or nil balance.