It is not classified as a liability since it does not represent a future obligation. The main advantage of using separate contra revenue accounts is that each one provides targeted information about the individual deductions taken from sales. Since each of these deductions directly reduces your profits, it makes sense to research them in detail, to see if there are any actions that can be taken to reduce the number of deductions. For example, this analysis might indicate that do i need a tax id number for my business your business has product quality problems or servicing issues that can be corrected.

Example of a Contra Account

At the same time, our Accounts Receivable Automation software and Accounts Payable Automation software makes tracking, managing, and processing crucial assets and liabilities — and their contras — easier than ever before. A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset. To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together. 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).

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A contra revenue account allows a company to see the original amount sold and to also see the items that reduced the sales to the amount of net sales. 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. Sales returns occur when a customer returns a product they previously purchased, a common occurrence in retail and e-commerce. As a business owner, you’ll record these returns as contra revenue because they reduce the initial sales amount reported. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount.

In order to record this ongoing value drop, you would use a corresponding contra account — an Asset Depreciation account. There is almost always a story behind data; a clarification or historical insight that changes the meaning behind raw figures. In a report, layering on that additional context can be easy, but in a general ledger, you have few options for conveying nuance and subtlety.

Contra Account

He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. To illustrate the contra revenue account Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit.

While both affect your net income, they do so in different parts of your income statement. Contra revenue accounts appear near the top of the income statement, as a deduction from gross revenue. If the amounts of these line items are minimal, they may be aggregated for reporting purposes into a single contra revenue line item. A sample presentation of contra revenue appears in the following exhibit, which contains the revenue-related line items found at the top of an income statement.

Sales returns

The following are examples of commonly-used contra asset accounts you could create to better understand your business financials. However, it’s important to keep in mind that you can create any contra account you want to more cost drivers definition examples clearly describe your business — this is not an exhaustive or definitive list. The list of asset accounts on your general ledger and balance sheet conveys the combined, potential value of all of the tangible and intangible items that your organization possesses. But in the real world, converting all of that potential into hard cash is highly unlikely, if not impossible.

1. Rather than pay this cost up-front and tie up a significant chunk of capital, Show-Fleur makes this purchase on credit with a 90-day due date after invoicing.
2. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.
3. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
4. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand.
5. In your financial statements, contra revenue accounts appear as deductions from gross sales to arrive at net sales.

How are contra accounts recorded?

For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. This type of account could be called the allowance for doubtful accounts or a bad debt reserve.

This means if you sold an item for $100 but gave a $10 allowance for a small scratch, you’d record $90 in net sales instead of the full $100. This guide is also related to our articles on understanding gross vs. net profit, understanding prepaid expenses, and understanding unearned revenue. For industries that rely on natural resources — mining, logging, oil, gas — depletion tracks the gradual exhaustion of the raw material in question, offsetting that loss in value against the initial appraisal of the land. So an Accumulated Depletion account would serve as the contra for the parent Fixed Asset account.

Nor would it count as a liability as it does not reflect a future obligation. These deductions, which come in the form of sales returns, allowances, and discounts, are not expenses but adjustments that lower the total sales on your income statement. 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.

We’ll also touch on related topics like gross vs. net profit, prepaid expenses, and unearned revenue. The sales allowances account is similar in use to the sales returns account, except that it deals with allowances given against a defective product which the customer has kept and not returned to the business. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold.