What is a contra-liability account?
On the balance sheet, the net liability for the bonds payable will be reported as $980,000 ($1,000,000 – $20,000), reflecting the impact of the discount on bonds payable. 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. In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount.
The contra liability account is less common than the contra asset account. An example of a contra liability account is the bond discount account, which offsets the bond payable account. A contra liability account is not classified as a liability, since it does not represent a future obligation. In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account. In other words, the contra liability account is used to adjust the book value of an asset or liability. The most common contra account is the accumulated depreciation account, which offsets the fixed asset account.
What are Contra Liability Accounts?
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. 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. A contra account is an account that is used to offset another account.
If a listed company purchases its own shares from the open market, it will have to debit the treasury stock account in order to record the transaction. A company might decide to purchase its stock when the board of directors feel the stock is undervalued or when it wishes to pay its shareholders dividends. When netted together, the two accounts yield the carrying value of a bond. A contra-liability account is a liability account in which the balance is expected to be a debit balance. Since a debit balance in a liability account is contrary to the normal credit balance, the account is referred to as a contra-liability account.
Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance. Thus, the natural balance of a contra account is always the opposite of the account with which it is paired. Contra liability accounts are a type of account in financial accounting that offset the balance of corresponding liability accounts. Contra liability accounts have a debit balance, which is the opposite of the typical credit balance found in liability accounts.
Understanding Contra Accounts
Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities include discount on notes or bonds payable. Contra liability accounts are not as popular as contra asset accounts. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation. A contra account offsets the balance in another, related account with which it is paired. Contra accounts appear in the financial statements directly below their paired accounts.
The accumulated depreciation amount shows how much depreciation expense has been charged against an asset. Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value. A contra account is an account with a balance opposite the normal accounts in its category. Contra accounts are usually linked to specific accounts on the balance sheet and are reported as subtractions from these accounts. In other words, contra accounts are used to reduce normal accounts on the balance sheet.
The OID is calculated as the difference between the redemption price and the discounted issuance price. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
- Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
- By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount.
- They serve an invaluable function in financial reporting that enhances transparency in accounting books.
- Contra accounts appear in the financial statements directly below their paired accounts.
Such accounts are allowance for doubtful accounts and the accumulated depreciation account. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced. In the event that a contra account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult. 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.
What is Junior Debt?
Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. 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. Bills payable or notes payable is a liability that is created when a company borrows any specific amount of money. If the company repays the loan early, the lender may provide a discount.
- Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue.
- Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.
- A liability that is recorded as a debit balance is used to decrease the balance of a liability.
- Sometimes the balances in the two accounts are merged for presentation purposes, so that only a net amount is presented.
- However, due to market conditions, Green Energy Corp. is only able to issue the bonds at 98% of their face value, meaning they receive $980,000 ($1,000,000 x 0.98) in proceeds from the bond issuance.
Similarly, accrued liabilities reduce the total amount of current liabilities. Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. Put simply, contra accounts are used to reduce the normal accounts on the balance sheet.
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. A liability that is recorded as a debit balance is used to decrease the balance of a liability.
Everything You Need To Master Financial Modeling
Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. We strive to empower readers with the most factual and reliable climate finance information possible to help them make informed decisions. Our goal is to deliver the most understandable and comprehensive explanations of climate and finance topics.
The reason financing fees are an example of a contra liability is that the fees – much like interest on the debt – are amortized over the debt borrowing term. The reason for recognizing a contra liability is to reduce the corresponding account for amounts that cannot be realized or collected, while not adjusting the historical cost. A Contra Liability carries a debit balance rather than a credit balance, which is the opposite of the normal balance carried by liabilities.
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 expense. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. If a contra account is not used, it can be difficult to determine historical costs, which can make tax preparation more difficult and time-consuming. The contra asset account carries a credit balance because an asset account usually has a debit balance.
For example, a building is acquired for $20,000, that $20,000 is recorded on the general ledger while the depreciation of the building is recorded separately. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Suppose a bond is issued at a discounted price – i.e. lower than the redemption price (or the stated “par value”). The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
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. Contra equity accounts carry a debit balance reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
Contra Equity Account – A contra equity account has a debit balance and decreases a standard equity account. Treasure stock is a good example as it carries a debit balance and decreases the overall stockholders’ equity. Let’s consider a fictional example of a company called “Green Energy Corp.” to illustrate the use of a contra liability account in financial accounting. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
The purpose of a contra liability account is to reduce the total liability shown on the balance sheet by reflecting specific adjustments, allowances, or discounts related to the liability. Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. This depreciation is saved in a contra asset account called accumulated depreciation. The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment. The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation.