Contra Account Accounting Definition + Journal Entry Examples
Many investors like to hold gold as it is viewed as an outperformer during tough times for the stock market. A contra market is a description of an asset or investment that moves against the trend of the broad market. Contra (or contrarian) market securities and sectors tend to have a negative correlation, or weak correlation, with the broader market index and the general economy. When the economy is weak or stock market indexes underperform, contra segments outperform, and vice versa.
Contra equity accounts are typically used for a company to buy back its stock or shares. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets. 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. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. The benefit of using the contra expense account is that the company’s managers can see in account 4210 the total amount that the company paid to the health insurance company.
Another description of a contra expense account is an account that reduces or offsets the amounts reported in another general ledger expense account(s). Although they all aim at reducing the balance of some type of account, it is useful to have some general foundational knowledge of the different types of accounts. This type of reporting allows anyone analyzing the balance sheet to understand much more about the company and its assets than if they were to simply look at the net value of the depreciated asset. By reflecting both accounts on the balance sheet, analysts can understand both the original price and the total decrease in value of a certain asset over time. Learn why contra accounts, when utilized correctly along with a paired account, are a crucial component of accurate accounting and financial review. All in all, contra accounts are an important tool for businesses to use to understand their financial standing better.
For example, a company might have a contra asset account for depreciation expense and a separate asset account for equipment cost. By reporting contra asset accounts on the balance sheet, users of financial statements can learn more about the what is a trial balance 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. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts.
- An example of contra equity with buying back shares or stock would be a company that has issued shares to the public.
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- A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment.
- This contra entry involves only accounts receivable and accounts payable.
- It happens when the company has accounts receivable and accounts payable with another company.
A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported. The net amount is often referred to as the carrying amount or perhaps the net realizable amount. This question is asked by many students, accountants, and professionals. This article will give you the definition of contra in accounting, talk about different contra accounts, and give examples.
Why are Contra Accounts Inportant?
In response, the firm should decrease its accounts receivable and revenue balances. That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100. Hence, the company will have gross revenue or net sales equal to $9,900. Contra assets are accounts in the general ledger—where you enter your transactions—that carry a balance used to offset the account with which it is paired. Instead of debiting the asset account directly, the contra asset account balance will be credited (reduced) separately. It would give a more accurate picture of the company’s fixed assets.
Therefore, the asset’s net value (or the book value) will be $70,000. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. So after the contra entry, the balance of accounts receivable will remain only $ 3,000 and there are no accounts payable. Contra Entry is the transaction that impacts both debit and credit of cash & cash equivalent. It is the transaction between cash, petty cash, bank, and other accounts under cash.
In case the contra asset account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. In the books, the account of the asset would have a debit value of $100,000, and the contra asset account would have a credit value of $30,000. If the asset account had a credit balance or the contra asset account had a debit balance, this would indicate an error in the journal entries.
The transfer of cash from one account to another is also considered as a contra entry. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. Debit and credit aspects of a single transaction are entered in the same account but in different columns. Each entry, in this case, is viewed as a contra entry of the other. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet. Treasury stock differs from other stocks in that it has no voting rights, and no dividends are paid to the treasury stock.
Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. 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). This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders.
Understanding a Contra Account
Treasuries and gold, which have the greatest appeal during economic turmoil, are also classic examples of contra market plays. ABC Computers makes sales of 90,000; unfortunately, due to a fault in a product, they received returns of 2,500. The sales will still show a sales credit on the profit and loss of 90,000, but there is also a contra returns account with a debit of 2,500. Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling. When the S&P 500 rose from 1995 to 2000, the price of gold declined and had a negative correlation. Gold started rising while stocks were falling, trading relatively flat and then picking up steam to the upside in mid-2001.
Contra liabilities
The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period. The allowance for doubtful accounts is a contra asset because it reduces the value of the accounts receivable (AR) account on the general ledger. Often when a company extends goods on credit, management expects some of those customers not to pay and so anticipates writing off bad debt.
What Is a Contra Market?
Possibly an investor believes the broader market will decline, and so they wish to gain some protection, or possibly profit, by moving some or all of their funds into contra markets. Or possibly the investor is a contrarian, meaning they prefer to buy or sell assets that go against the flow of the broader market or economy. The investor may also simply want to diversify and not hold only assets that tend to move in the same direction. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. The above amount is recorded in the bank column (debit) side of the double column cash book. Suppose a clothing business has sold $50,000 of inventory on credit.
Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts). The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable. Therefore, the net amount of the accounts receivable that is expected to turn to cash is $38,000. Contra liability, equity, and revenue accounts have natural debit balances.
Definition of Contra Expense Account
The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets.
Many investors like to hold gold as it is viewed as an outperformer during tough times for the stock market. A contra market is a description of an asset or investment that moves against the trend of the broad market. Contra (or contrarian) market securities and sectors tend to have a negative correlation, or weak correlation, with…