What is Contra Account? Definition + Journal Entry Examples

Since you no longer have the shoes, aka the asset, you record a $20 expense on your income statement, But you also record $30 in revenue from the sale, so your net income is $10. Of course, you’ll also have to pay your employees’ wages, your rent, your utilities and other costs. Those are expenses, too, because, without them, you wouldn’t have had a store in which to sell the shoes and collect the revenue. Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. In accrual-basis accounting, recording the allowance for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time.

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Chapter 6: Accounting For a Merchandising Enterprise

This type of account could be called the allowance for doubtful 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. The amount is reported on the balance sheet in the asset section immediately below accounts receivable. You can also record contra revenue within the sales account, but this means that it will be buried within the total amount of revenue reported, so that management cannot easily determine the amount of contra revenue.

• Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.
• The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers.
• Each of these accounts helps to offset another account on the balance sheet.

When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet. If the related account has a debit as the natural balance, then the contra account will record a credit. Most companies pay their sales representatives a salary plus a bonus or commissions. The answer is based on the future, because smart brand owners want to motivate and push their sales representatives to do more.

Contra accounts increase transparency

For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. Understanding the reasons for a contra-revenue channel marketing program enables channel managers to be more strategic. They can combine the right programs and adjust the investment amounts in each program to better align channel payouts to the brand owner’s growth https://www.bookstime.com/articles/contra-revenue-account strategies. Instead of being against (contra) revenue, the ultimate outcome is long-term results and strong, consistent sales performance from a loyal channel. If these programs reduce your top-line revenue as a brand owner while increasing complexity and costs, why use them? The difference between an asset’s account balance and the contra account balance is known as the book value.

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 this example, the contra revenue accounts (Sales Returns and Allowances and Sales Discounts) are used to provide a more accurate and detailed representation of the company’s revenue position. On the income statement, the net sales revenue will be reported as $47,000 ($50,000 – $2,000 – $1,000), reflecting the impact of the contra revenue accounts. The amount for estimated uncollectible accounts is a bad debt operating expense.

What Is a Contra Account?

As a participant in the brand owner’s incentive program, the distributor and its sales reps are entitled to receive rebates, SPIFs and MDF. Rebates to the distributor represent 4% of sales, SPIFs for the sales reps are 1.5% and MDF amounts to 2.5%. In total, the brand owner spends 8% ($80,000) on incentives given to the distributor. This $80,000 is typically subtracted from revenue to calculate the net revenue of $920,000. Some accountants will keep a reference handy to know if the debit increases or the credit increases an account. The normal balance of a contra account, and the debit or credit, will be the opposite of the entry and normal balance in the parent account.

They want to take advantage of the interest free year of credit, so on December 5th they open a store account for the entire balance of $7,500 and make arrangements for delivery of the queen size bedroom set. To report the real value of the financial statement, you will need to record the amount you can reasonably estimate that will probably effect the financial statement classification. Accounting is how we tell a story about an economic event or financial transaction, such as a purchase or a withdrawal of money, for example. Periodic financial statements report the impact of the story and are used by leaders of a firm or industry to analyze performance, plan, and respond. The Integrity at HP embody the fundamental principles that govern our ethical and legal obligations to HP.

Contra revenue definition

The most common contra assets are accumulated depreciation and the allowance for doubtful accounts. For example, the debit will be to the expense account in an estimated uncollectible amount from a credit sale. The credit will be to the asset account or allowance for doubtful accounts. https://www.bookstime.com/ accounts show the deducting adjustments to gross revenue or producing net revenue.

A contra account is an account that records events like adjustments and transactions that are having an opposite effect on a relating account’s true value on the firm’s financial statements. If we record those events within the relating account, we risk losing information that is relevant to analyzing performance. Consider what would happen if you have sales on credit that you reasonably expect will not be paid. In the example of Homes Inc. the percentage of customers defaulting on the account, and the amount defaulted, is estimable and probable. Past experience with uncollected bad debt has been, on average, 10% of credit sales.

What are the different types of contra accounts?

Credit sales are often risky because the chance of not collecting on the accounts receivable increases uncollectable percentages of credit sales, where the amount must be estimable and probable. Accounting for the contrary in a business will show the normal business account value, the attached contra account underneath it, with the net revenue the business experienced below. This type is paired with the asset account, which allows a business to record the original price or value of the asset at time of purchase. The contra asset account then allows recording of the value factoring in depreciation. An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable. The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers.

• In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses.
• A key example of contra liabilities include discount on notes or bonds payable.
• Contra liability, equity, and revenue accounts have natural debit balances.
• The purpose of a contra account is to accurately report value of operating performance and assets for a firm.
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• High return levels may indicate the presence of serious but correctable problems.

The sale to the Johnson family will create a bad debt expense estimate of 10% of the amount receivable. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account.

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.