A Contra account is the creation of an opposite account balance in the balance sheet. It helps to reduce the normal account balance without impacting the original account. For instance, the accumulated depreciation is used as a contra account against fixed assets classified in the financial statement.
Also read, fictitious assets
The accounting record of the business contains different account balances like assets, liabilities, and equity. Accounting transactions are posted in the chart of accounts to reflect economic movement. For instance, a sales account is credited to reflect receipt of the economic benefit. However, sometimes, some accounting transactions require a chart of accounts to remain unaffected, and another related account is created to reflect the transaction in opposite direction. This related account is called a contra- account.
For instance, allowance for bad debt does not directly reduce debtor balance. Similarly, depreciation does not directly reduce the cost of the asset. In fact, we create another related account and park opposite entries to reflect the substance of the transactions. However, this account is removed from the books of accounts once its purpose of recording is completed.
The balance posted in the contra is net off against the main account and reported in the balance sheet. For instance, accumulated depreciation is deducted from the cost of assets, and allowance for bad debt is deducted from the gross receivable balance before reporting on the face of the balance sheet. Although, detailed movement of the balance can be provided in the balance sheet.
The purpose of using this account is to trace the historical cost of the asset. So, if you decrease the balance of the account, it will be difficult to trace the account balance later on. Hence, a contra account is created to avoid difficulty.
Contra account entry
The entry is posted in connection with the main account balance. Contra entry is needed when the business does not post in the main account but related account. Let’s understand contra entry for depreciation and allowance for debtors.
Contra account entry for depreciation
Accumulated depreciation is contra account. Its temporary account was created against the assets. Hence, it’s removed from books of accounts when the asset is sold. Following entry is passed in the books of accounts.
|Cost of the asset
Please note we have posted a credit balance in the accumulated depreciation account, and we’ve reversed the balance by creating debit in the same account. Hence, it was a temporary account created to satisfy the accounting needs. Hence accumulated depreciation is contra in na.
Contra entry example (presentation)
Following are the examples of contra entry accounts in terms of allowance and depreciation.
|Allowance for receivables
|Cost of an asset
|Gross accounts receivables
|Less accumulated depreciation (contra account)
|Fewer accounts receivable (contra account)
|Net Book Value
It’s important to note that the third line of the table contains a contra which is a temporary credit balance and removed when the asset is sold, and the balance of receivable is written off.
Contra account is temporary and accounts created to satisfy accounting needs. However, it’s only included when we do not want to alter the balance of the main account. Instead, the main account remains the same. However, the related account is created in the opposite direction.
Further, there are two main examples of the contra that include accumulated depreciation and the allowance for receivables.