Contra Account - Explained
What is a Contra Account?
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Table of ContentsWhat is a Contra Account?How is a Contra Account Used? Examples of Contra AccountsMaintenance of Historical CostDetermining Book ValueFinancial Statement PresentationAcademic Research on Contra Accounts
What is a Contra Account?
A contra account is an account whose balance is the opposite of a corresponding account. In finance, a contra account reduces the value of related or corresponding account. It offsets the balance of the related account, which means when the corresponding account is positive, a contra account will be negative.
How is a Contra Account Used?
A contra account is used for account classification and is also reported in a company's financial statement alongside its corresponding or related account. When reporting a contra account in a company's financial statement, it is reported immediately below the account it relates to or corresponds. Contra accounts have different names depending on the account they correspond. For instance, a contra account that relates to an accounts receivable is called a contra asset account.
Examples of Contra Accounts
The Allowance for Uncollectible Accounts is another name given to a contra account associated with accounts receivable. This account reduces the amount of accounts receivable reported in a company's financial statement, this is because it represents the estimated amount that will be uncollected. The amounts in the accounts are recorded in dollars. If the amount in the contra account increases, it becomes a bad debt expense when recording the income statement. Here is an example; If company A has $25,000 in its accounts receivable and estimates that 10% would be uncollected. $2,500 is recorded in its contra account (Allowance for Uncollectible Accounts). When reporting these corresponding accounts in the company's balance sheet, the net amount will be $22,500 while the $2,500 in the contra account would be reported in the income statement as bad debt expenses.
Maintenance of Historical Cost
Contra accounts are helpful in determining the historical cost of a company, these accounts help financial managers and accountants keep a clean and easy-to -track financial records. Maintaining a good record of historical cost is important for tax preparation. Hence, contra accounts are not just meant for the purpose of reducing the value of the associated accounts, they are useful in tax preparation. Companies use this account for transparency in financial reporting.
Determining Book Value
The book value of an asset is the value of the asset recorded in the company's balance sheet. Contra accounts are needed for determining the book value of assets held by a company. For accounting purposes, the book value is realized by the difference between the asset's account balance and contra account balance. Contra accounts play a major role in estimating the book value of an asset.
Financial Statement Presentation
When compiling or recording a financial statement, a contra account is recorded immediately before the account or corresponds or relates to. It is often presented as a negative value underneath the main account. Contra accounts and the associated accounts are reported in dollar value. For example, an Allowance for Uncollectible Accounts is the contra account for accounts receivable which often offsets the balance of the account. An Allowance for Uncollectible Accounts is reported on a line directly below the accounts receivable in a company's financial statements.