What is a Contra Inventory Account?

For example, when your company borrows money, you would identify that debt in a Notes Payable account. Furthermore, if you subsequently pay off that debt early and capture a discount, the contra liability account — Discount Notes Payable — would record those savings. Another common contra liability account is a Discount on Bonds Payable account used by businesses that issue their own bonds. 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. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns.

  • Every year, a company has an inventory that will not be able to be sold for various reasons.
  • Contra revenue carries a debit balance and may be listed as sales discounts, sales returns, or sales allowances.
  • Wanting to spruce up its aging inventory, Show-Fleur purchased new, climate controlled-seats for its fleet, delivering increased comfort for passengers and a cleaner, more modern look for vehicle interiors.
  • For example, when depreciating an asset, the accumulated depreciation account is used to reduce the book value of the asset while also keeping track of the total amount of depreciation that has been posted to date.

Contra equity accounts reduce shareholders’ equity and contra revenues account for a reduction of collected income. Using contra accounts can allow financial statement users to prepare annual reports and calculate net values more efficiently what is the monetary unit assumption in financial reporting and are an important part of the accounting toolkit. Just like contra asset accounts offset the positive values of assets on the balance sheet, contra liabilities offset the negative value of liabilities on the balance sheet.

Examples of Contra Accounts

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. Revenues do not appear on the balance sheet but are listed as part of the income statement.

This general structure can be applied across all contra types, so if the parent account has a credit, the contra account will have a debit. Similarly, if the parent account lists entries as debits, the contra account will appear as a credit. You could commit a minor amount of reporting fraud by increasing the size of the inventory reserve during profitable periods and using this inflated reserve to draw down the balance when you need to increase reported profits. This sort of behavior is not condoned, and may be spotted by auditors who want to see a valid justification for any unusual changes to the reserve.

Namely, within a ledger, each account is intended to contain transactions and balances of a similar type only. But sometimes, dissimilar transactions are important to consider together within a ledger. 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.

For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts. The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts. At first glance, contra accounts may seem complicated, but contra accounts exist to simplify financial statements. Contra asset accounts appear as a credit balance and reduce the value of assets. Contra liabilities appear as a debit balance and reduce the amount a company owes.

  • In order to create a balance between the two methods and to give a fuller picture of a company’s financial realities, the LIFO reserve account is necessary.
  • This frequently happens to manufacturing companies that sell products with an expiration date since any inventory remaining in stock past the expiration date quickly becomes obsolete.
  • Within equity, an example of a contra account is the treasury stock account; it is a deduction from equity, because it represents the amount paid by a corporation to buy back its stock.
  • Once inventory that is unable to be sold is actually identified it is written down in official recognition of the loss.
  • Just like contra asset accounts offset the positive values of assets on the balance sheet, contra liabilities offset the negative value of liabilities on the balance sheet.
  • The LIFO method places a higher rate of cost on all the goods that a company sells over the period of a year.

By accounting industry standards, inventory reserve is a conservative methodology. It attempts to predict inventory losses even before a loss has been confirmed to have happened. As such, inventories are made up of goods that have future economic value, which qualifies them as assets. The principles of conservative accounting prescribe reporting assets as close to their current value as possible. In this example, the contra inventory account (Allowance for Obsolete Inventory) is used to provide a more accurate and detailed representation of the company’s inventory position. By accounting for obsolescence and other adjustments, TechShop can track its actual inventory value more effectively and make more informed decisions about its inventory management and purchasing strategies.

Contra account examples

In either case, using these accounts can help you better manage depreciation expense, keep your accounts receivable balance accurate, and properly dispose of and account for obsolete inventory. Asset accounts always maintain a debit balance, so anytime that you increase the value of an asset, such as when you deposit customer payments or invoice a customer, that asset account is debited or increased. Likewise, when you pay a bill, your cash account is reduced (credited) because you’re lowering the balance. Let’s consider a fictional example of a small electronics retail business called “TechShop” to illustrate the use of a contra inventory account in financial accounting. A contra account provides missing context by pairing it with a related account.

The purpose of contra accounts

The initial cost of this upgrade was $8 thousand per limo or $600,000 in total. For industries that rely on natural resources — mining, logging, oil, gas — depletion tracks the gradual exhaustion of the raw material in question, offsetting that loss in value against the initial appraisal of the land. So an Accumulated Depletion account would serve as the contra for the parent Fixed Asset account.

What is a contra account?

TechShop performs an inventory review and identifies that a portion of its inventory, worth $10,000, is likely to become obsolete due to new product releases and changing customer preferences. (Or so we’ve been told.) Reach out to us today for all of your bookkeeping and business consulting needs. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Contra liability accounts

For each debit against the inventory account, there will be a corresponding credit against the obsolete inventory contra account. Most accountants choose to record the depreciation over the useful life of an item in the accumulated depreciation contra asset account, which is a credit account. The balance sheet would show the piece of equipment at its historical cost, then subtract the accumulated depreciation to reflect the accurate value of the asset. 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. When a contra asset account is first recorded in a journal entry, the offset is to an expense.

Inventory reserve is an estimation of future inventory spoilage based on the company’s past experiences. Once inventory that is unable to be sold is actually identified it is written down in official recognition of the loss. A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines.