What is a Contra Account? Definition
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.
Types of Contra Accounts – Explanation
There are a few different types of contra accounts in the chart of accounts. Each one is tied to their respective asset, liability, or equity account to reduce their carrying balance on the balance sheet. Here’s a list of the main types of contra accounts:
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. An example of this is accumulated depreciation. This account decreases the fixed asset carrying balance.
Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet. An example of this is a discount on bonds payable.
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.
How are Contra Accounts Used and Reported?
Take the equipment account for example. Equipment is a long-term asset account that has a debit balance. Equipment is depreciated over its useful. 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.
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. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset.
The same is true for other asset accounts like accounts receivable. 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. This shows investors how much receivables are still good. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off.
Here is an example of a depreciation journal entry.