It shows the amount of funds used to repurchase previous issuances of stock, reducing the total number of shares outstanding. Original issue discounts are a type of contra liability like financing fees because they are also amortized over a loan’s term and reduce pre-tax income. The purpose of recording OID as a contra account is to quickly show the difference between the redemption price and the discounted offering price of debt. The obsolete inventory reserve account is the contra account to inventory, another asset listed on the balance sheet. Products that become unusable are recorded in this contra account to show that they are still owned by the company, but they should be excluded from the market value of inventory.

• Free Cash Flow The money left over after a company supports operations can be a snapshot of its financial health.
• Although contra asset accounts have credit balances, they do not appear in liabilities or equity.
• Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.
• Examples of contra liabilities are Discounts on Bonds and Notes Payable and Short-Term Portion of Long-Term Debt.

Each of these accounts helps to offset another account on the balance sheet. Learn about the meaning of contra accounts, how and why they are used, and how to account for balances with them. The book value of an asset is the value of the asset recorded in the company’s balance sheet. Contra accounts are needed for determining the book value of assets held by a company. For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset.

How Contra Asset Accounts Work

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. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt construction bookkeeping expense. Balance sheet, users of financial statements can learn more about the assets of a company. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.

• As the name indicates, sales return accounts are maintained to record the return of goods by customers, if any.
• The debit balance of the asset account and the credit balance of the contra asset account determine the net value of the asset.
• A key example of contra liabilities include discount on notes or bonds payable.
• These contra revenue accounts tend to have a debit balance and are used to calculate net sales.

If you are using the Multi-Book feature, in the Accounting Book field, select the accounting book. The following information is available from the financial records of X Company. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Nora O’Malley covers small business finance and entrepreneurship topics for The Balance. Along with her writing work, Nora is an entrepreneur and consultant who opened an all-tap wine bar in New York’s East Village dubbed Lois and owns a sophisticated snack food business Aida.

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Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet. Contra Asset Account – A contra asset account is an asset that carries a credit balance and is used to decrease the balance of another asset on the balance.

• The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
• The accumulated depreciation amount shows how much depreciation expense has been charged against an asset.
• Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances.
• A transaction is made under the sales return account when a customer returns a product to the company for a refund.
• In a sense, a contra asset account is a negative asset account that detracts from all of the other assets included in the balance sheet.
• If the related account is an asset account, then a contra asset account is used to offset it with a credit balance.

This can be seen as a refund or the loss of revenue for the returned goods. Businesses use sales returns accounts to track product issues and customer trends. Whether reported as separate lines on the financial report or as a cumulative value, the net amount of the pair of accounts is called the “net book value” of the individual asset.

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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. This type of account could be called the allowance for doubtful accounts accounting contra accounts or bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. An example where accumulated depreciation account of plant and machinery is a contra a/c account linked to company’s plant and machinery. As an example, if the value of machinery is $500,000 at the end of the year, this is the net value of the machinery.

Contra revenue account, which is used to record the net amounts and usually has a debit balance, as opposed to the revenue account that records the gross amounts. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative. On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead. A contra liability account is a liability account that is debited in order to offset a credit to another liability account. Simply looking at the accounting records of a given business, one can reach back to the history related to certain debits and credits. For instance, the allowance for doubtful accounts reduces the net amount of accounts receivable, while the reserve for obsolete inventory does the same for inventory.

The situations that contra asset accounts appear are the ones dealing with Depreciation, which will be explored below. A contra account is used for account classification and is also reported in a company’s financial statement alongside its corresponding or related account. When reporting a contra account in a company’s financial statement, it is reported immediately below the account it relates to or corresponds. Contra accounts have different names depending on the account they correspond. For instance, a contra account that relates to an accounts receivable is called a contra asset account. 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.

Usually, Liability accounts, Revenue accounts, Equity Accounts, Contra-Expense & Contra-Asset accounts tend to have the credit balance. This account is not classified as an asset since it does not represent a long-term value. It is not classified as a liability since it does not constitute a future obligation.