The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. The sales returns account contains either an allowance for returned goods, or the actual amount of revenue deduction attributable to returned goods. It is especially important to track sales returns separately and on a trend line, since this can provide important evidence of problems with a company’s products that are causing customers to return goods. In your income statement, the gross sales are $50,000 less than the sales returns and allowances of $1000. Contra accounts are used to help a company report the original amount of a transaction as well as reductions that may have happened.
For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
contra revenues account definition
An example of a contra liabilities account is an account entitled ‘Discount on Bonds Payable’ and may refer to an instance when the bonds decreed interest rate is less than its market interest rate. Finally, the contra equity account is a shareholders’ equity account that has a net debit balance and reduces the overall equity held by a business. An example of a contra equity account may be ‘Owner Drawings’ which will show the funds withdrawn by the business owner in opposition to the equity account that displays the credit balance of shareholders’ equity. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts. Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position.
- Your asset account will normally be in a credit balance because the cost principle means that when you acquire an asset, it’s recorded in your asset account at the cash amount or equivalent.
- This contra asset account may be entitled ‘Accumulated Depreciation’ and will record the cumulative depreciation of your plant assets, (property, plant and equipment).
- In addition, you can examine the impact of sales discounts on increases in sales, to see if it makes sense to continue offering discounts in order to boost profits.
- Company K’s income statement will report the gross Sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales of $99,500.
Contra accounts 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 liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation.
Is a Contra Balance Negative or Positive?
If the company repays the loan early, the lender may provide a discount. This discount is subtracted from the total amount borrowed to better reflect the discount given by the lender. When the original dollar amount is kept in the original account and a separate account is used for recording the deduction, the resulting financial information becomes more transparent and helpful for stakeholders.
- Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts.
- Another type of contra account is known as “contra revenue,” which is used to adjust gross revenue to calculate net revenue, i.e. the “final” revenue figure listed on the income statement.
- A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability.
- The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account.
Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. A key example of contra liabilities includes discounts on notes or bonds payable. There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue.
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Similarly, accrued liabilities reduce the total amount of current liabilities. Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. When a contra asset account is first recorded in a journal entry, the offset is to an expense.
If Company A offers a two percent discount on the total amount if paid within a week instead of the usual 30 days, the company records the discounted amount in its contra account as Sales Discounts. The company would see the original amount, discounted sale, and net sales in the contra revenue account. If this is part of your business model, you’ll want to record every refund, return or discount in your contra revenue account to help you better understand the differences between your gross revenue and the net revenue.
Advantages of Contra Revenue
A contra revenue account allows a company to see the original amount sold and to also see the items that reduced the sales to the amount of net sales. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account.
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. Examples of contra accounts include allowance for doubtful accounts, reserve for obsolete inventory, and accrued liabilities. Each of these accounts helps to offset another account on the balance sheet. For instance, the allowance for doubtful accounts reduces the net amount of accounts receivable, while the reserve for obsolete inventory does the same for inventory.
