What is a contra account?
Let’s go through the concept of contra accounts using lots of examples!
The main thing to understand about contra accounts is that contra means opposite.
Contra accounts are linked with another account, and have an opposite balance.
The usual pattern is gross amount minus the amount in the contra account is net amount.
Let’s first take a look at contra accounts on the balance sheet.
As you know from studying the basics of debits and credits, balance sheet accounts have a
natural state.
Assets accounts have a debit balance.
Liability accounts have a credit balance.
Equity accounts have a credit balance.
A contra account has an opposite balance.
A contra asset account has a credit balance.
A contra liability account has a debit balance.
A contra equity account has a debit balance.
Remember that contra accounts are always linked with another account,
they don’t exist in isolation.
A contra asset account is not the same as a liability.
A contra liability account is not the same as an asset.
The following examples will show you why!
For a lot of companies, Property, Plant and Equipment (or “Fixed Assets”) is a big
account in assets.
A subaccount of Property, Plant and Equipment would be PP&E @ Purchase, where you record
the original amount of investment made.
When the asset is put into use, you book depreciation expense in the income statement as a debit,
and record the offsetting credit in a contra asset account called Accumulated Depreciation.
By having these two separate accounts on the balance sheet (an asset account and a contra
asset account), you keep this important information easy to retrieve: how much you bought it for,
and how much you have depreciated on it so far.
The two accounts combined give you Net Property Plant and Equipment.
100 in assets, minus 20 in contra assets is net 80.
This is what I meant by saying that contra accounts are linked with another account and
have an opposite balance.
You subtract the amount in a contra account from the other account’s balance to get
the net amount.
The second example of a contra asset account is Accounts Receivable.
50 of outstanding Accounts Receivable (invoices sent to customers that the customers have
not paid yet), minus an estimated allowance for doubtful debt of 3 (an estimate of the
amount that is uncollectible), gets you to Accounts Receivable net of allowances of 47.
For the allowance for doubtful debt contra account which has a credit balance of 3, the
offset to the journal entry was a debit in bad debt expense in the income statement of 3.
Liabilities can also have a contra liability account.
For example, the Notes Payable liability for the company in this example is 20 (credit),
offset by a discount on notes payable of 1 in a contra liability account (debit), to
get to Net Notes Payable of 19.
Similar thing in equity.
Paid-in Capital of 70 (credit), minus 20 (debit) recorded in the contra equity account Treasury
Stock, to get to net 50 in Equity.
Let’s move from the balance sheet to the income statement.
Income statement accounts can also have a contra account.
For expense accounts, the natural state is a debit balance.
For Revenue accounts, the natural state is a credit balance.
A contra expense account has a credit balance.
A contra revenue account has a debit balance.
Remember that contra accounts are always linked with another account,
they don’t exist in isolation.
The following income statement contra account examples will show you why!
In expenses for a manufacturing company producing and selling product, cost of goods sold is
a major expense category.
Cost of Goods Sold is 100, minus a little bit of negative expense of 2 in the contra
account called “sale of scrap”, to get to Net Cost of Goods Sold of 98.
In revenue, an example of a contra revenue account is sales discounts.
Gross revenue of 200, minus 4 in the contra revenue account called Sales Discounts, gets
you to Net Revenue of 196.
The main thing to understand about contra accounts is that contra means opposite.
Contra accounts are linked with another account, and have an opposite balance.
The usual pattern is gross amount minus the amount in the contra account is net amount.
I hope you enjoyed this short explanation of contra accounts in accounting.
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