Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950. The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings. There can be hidden value in stocks that have a lot of fully depreciated buildings.
Key Takeaways
In other words, the contra liability account is used to adjust the book value of an asset or liability. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find. Companies bury them in the footnotes and often don’t break out the actual calculation. Still, https://www.kelleysbookkeeping.com/ it is important when possible to consider how the net accounts are calculated and be wary of companies that are reporting a ton of bad debts. Allowance for doubtful accounts is netted from the accounts receivable balance. The company predicts which accounts receivable won’t be paid by customers and writes those off.
Understanding contra accounts
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. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. In bookkeeping, a contra asset account is an asset account in which the natural balance of the account will either be a zero or a credit (negative) balance. The account offsets the balance in the respective asset account that it is paired with on the balance sheet.
Contra liabilities
A contra asset account is not classified as an asset, since it does not represent long-term value, nor is it classified as a liability, since it does not represent a future obligation. Contra accounts https://www.kelleysbookkeeping.com/fixed-vs-variable-expenses/ are used to reduce the original account directly, keeping financial accounting records clean. The difference between an asset’s balance and the contra account asset balance is the book value.
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. Reserve for obsolete inventory is a contra asset account used to write down the inventory account if inventory is considered how to calculate sales tax on gross income obsolete. Excess, stored inventory will near the end of its lifespan at some point and, in turn, result in expired or unsellable goods. In this scenario, a write-down is recorded to the reserve for obsolete inventory. The difference between an asset’s account balance and the contra account balance is known as the book value.
Offsetting the asset account with its respective contra asset account shows the net balance of that asset. 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.
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. 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 B/S impact is where the contra liability comes into play, i.e. the historical value of the debt is not impacted by the OID.
- Revenue is an income statement account, but it flows through to the equity section of retained earnings as well.
- The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance.
- 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).
- A second example of a contra asset account is Accumulated Depreciation.
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. To illustrate, let’s use the contra asset account Allowance for Doubtful Accounts. 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).
