Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000. An entry which affects both cash and bank accounts is called a contra entry. The debit and credit aspects of the transaction are recorded in the cash book itself in contra entries.
Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. If your company has minimal contra revenue activity, it is acceptable to record these transactions within the revenue account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.
For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services. The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables. Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
- Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.
- Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.
- Allowance for obsolete inventory or obsolete inventory reserve are also examples of contra asset accounts.
- By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes.
Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. The sales allowances account contains either an allowance for reductions in the price of a product that has minor defects, or the actual amount of the allowance attributable to specific sales.
What is a contra revenue account?
Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset. To illustrate the contra revenue account Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit. what is overtime If a customer returns $500 of this merchandise, Company K will debit Sales Returns and Allowances for $500 and will credit Accounts Receivable for $500. Company K’s income statement will report the gross Sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales of $99,500.
To illustrate the contra revenue account Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit. It will debit Accounts Receivable for $100,000 and credit to Sales for $100,000. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the assets of a company. Contra asset accounts allow users to see how much of an asset was written off, its remaining useful life, and the value of the asset.
The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. GAAP, the allowance for doubtful accounts represents management’s estimate of the percentage of “uncollectible” accounts receivable (i.e. the credit purchases from customers that are not expected to be paid). The sales discounts account contains the amount of sales discounts given to customers, which is usually a discount given in exchange for early payments by them.
- Accumulated depreciation reflects the reduction in value of a fixed asset.
- We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R).
- The sales discounts contra revenue account records the discounts given to customers on sales made to them, normally a cash or settlement discount.
- The allowance for doubtful accounts appears on the balance sheet and reduces the amount of receivables.
- Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc.
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own.
Contra accounts are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value. The sales discount account represents the discount amount a company gives to customers as an incentive to purchase its products or services. Allowance for doubtful accounts is a common contra asset listed on a company’s balance sheet under accounts receivable. Normal asset accounts have a debit balance, while contra asset accounts are in a credit balance.
A contra revenue account is a revenue account that is expected to have a debit balance (instead of the usual credit balance). In other words, its expected balance is contrary to—or opposite of—the usual credit balance in a revenue account. Company K’s income statement will report the gross Sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales of $99,500.
What Is the Benefit of Using a Contra Account?
Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets.
Join PRO or PRO Plus and Get Lifetime Access to Our Premium Materials
In double entry bookkeeping terms, a contra revenue account or contra sales account refers to an account which is offset against a revenue account. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. A debit will be made to the bad debt expense for $4,000 to balance the journal entry.
Sales Returns Account
Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. Generally in the financial statements the revenue account would be offset against the contra revenue account to show the net balance. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. Contra revenue accounts appear near the top of the income statement, as a deduction from gross revenue.
Managers and investors must understand contra accounts to accurately analyze a company’s balance sheet and determine the organization’s financial position. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. Transactions made to contra accounts are presented on a company’s financial statements under the related account. Contra accounts are important because they allow a company to follow the matching principle by recording an expense initially in the contra asset account.
Accumulated depreciation offsets a company’s real property assets, such as buildings, equipment and machinery. Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset. A transaction is made under the sales return account when a customer returns a product to the company for a refund.
Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a credit
balance. By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.