For example, if an asset account which is expected to have a debit balance, shows a credit balance, then this is considered to be an abnormal balance. In double entry bookkeeping the contra account purchases discount has a normal debit balance. terms, a contra expense account refers to an account which is offset against an expense account. Let’s consider a fictional example of a small retail business called “GadgetHub” to illustrate the use of a contra expense account in financial accounting.
Income Statement
A copy of Carbon Collective’s current written disclosure statement discussing Carbon Collective’s business operations, services, and fees is available at the SEC’s investment adviser public information website – or our legal documents here. When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. A contra account is a general ledger account with a balance that is the opposite of another, related account that it is paired with. The B/S impact is where the contra liability comes into play, i.e. the historical value of the debt is not impacted by the OID. In spite of its name, contra liabilities function more similarly to assets. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups.
Purchase Discounts, Returns and Allowances are contra expense accounts that carry a credit balance, which is contrary to the normal debit balance of regular expense accounts. Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances.
- From the table above it can be seen that assets, expenses, and dividends normally have a debit balance, whereas liabilities, capital, and revenue normally have a credit balance.
- The biggest problem students have with this topic is confusing purchase and sale transactions.
- Contra accounts are more commonly paired with asset accounts, such as accounts receivable or inventory, to reduce the carrying values of those assets.
- 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.
- For example, a grocery store displays advertisements for a national brand in its weekly flyer.
We will use a contra account, Sales Discounts, to record the discount amount. To record these transactions, GadgetHub will create a contra expense account called “Purchase Discounts. Of that amount, it is estimated that 1% of that amount will become bad debt at some point in the future. This means that the $85,000 balance is overstated compared to its real value. At this point, it isn’t known which accounts will become uncollectible so the Accounts Receivable balance isn’t adjusted.
A liability that is recorded as a debit balance is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position. Obsolete, Unsold and Unusable Inventory are contra asset accounts with a credit balance that reduce the normal debit balance of the main Inventory asset account in order to present the net value of inventory on a company’s balance sheet. Accumulated Depreciation is a contra asset account with a credit balance that reduces the normal debit balance of Property, Plant and Equipment fixed assets in order to present the net value of long-term capital assets on a company’s balance sheet.
AUD CPA Practice Questions: Business Cycles
Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. It should be noted that if an account is normally a debit balance it is increased by a debit entry, and if an account is normally a credit balance it is increased by a credit entry. So for example a debit entry to an asset account will increase the asset balance, and a credit entry to a liability account will increase the liability. The cost of goods sold (COGS) account will have a debit balance of $100,000, representing the initial cost of the inventory. The purchase discounts account will have a credit balance of $2,000 (2% of $100,000), which represents the discount received from the supplier. The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement.
Example #1: Revenue Contra Account
Since the purpose of the contra account is to be offset against the balance on another account, it follows that the normal balance on the contra account will be the opposite of the original account. The biggest problem students have with this topic is confusing purchase and sale transactions. I have had students do the problem perfectly, except they give me the journal entries for the purchase when I ask for the sale or vice versa. Spend extra time if needed to make sure that you understand what the transaction actually means.
Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. A contra expense account is a type of account in financial accounting that offsets the balance of a corresponding expense account. Contra expense accounts have a credit balance, which is the opposite of the typical debit balance found in expense accounts. The purpose of a contra expense account is to reduce the total expenses shown on the income statement by reflecting specific adjustments, recoveries, or reimbursements related to the expense.
By using a contra account, the company knows how much its sales were over the course of the year and how much was lost because of discounts and other items. This is good information for managers to have in order to make decisions about the effectiveness of company policy. A delivery van is purchased by a business to use in delivering product and picking up materials. The company uses Straight-Line Depreciation to track the loss of value of the asset over time.
Cash Flow Statement
A buyer debits Cash in Bank if a purchase return or allowance involves a refund of a payment that the buyer has already made to a seller. A buyer debits Accounts Payable if the original purchase was made on credit and the payment has not yet been made to a seller. A common example of a purchase discount are the NET D payment terms, such as 2/10 Net 30, where a buyer receives a 2% discount if an invoice is paid early within 10 days, otherwise a full payment is due in 30 days. For this reason the account balance for items on the left hand side of the equation is normally a debit and the account balance for items on the right side of the equation is normally a credit. Medici Music purchases instruments to sell in its stores from Whistling Flutes, LLC on August 13.
Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. From the table above it can be seen that assets, expenses, and dividends normally have a debit balance, whereas liabilities, capital, and revenue normally have a credit balance. By providing a clear and transparent mechanism to account for adjustments, these accounts enable stakeholders, including investors and creditors, to better understand a company’s financial health. For instance, ”Sales Returns and Allowances” is a contra account entry used to record returned merchandise or customer allowances, allowing a company to track and report these adjustments separately from regular sales revenue. However, that $1.4 billion is used to reduce the balance of gross accounts receivable.
Contra liability accounts are not as popular as contra asset accounts. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra assets decrease the balance of a fixed or capital asset, carrying a credit balance. Contra liabilities reduce liability accounts and carry a debit balance.
A debit will be made to the bad debt expense for $4,000 to balance the journal entry. 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. In the accounting general ledger, the credit balances of the contra purchase expense accounts reduce and offset the usual debit balances reported in the standard purchase expense accounts.