In reality, the actual number of company discounts came closer to $5 thousand. Now, if that sounded like a lot of mumbo-jumbo jargon to you, don’t worry. In this article, we’re going on a deep dive into what exactly a contra account is, how contra accounts work, why and how you would use contra accounts and more. 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. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance.

  • By viewing these accounts — the parent and contra — in tandem, business owners can gain broader insights, preserve the historical figures stored in the parent account, and make accommodations for any relevant changes.
  • To put it another way, a contra account is an account listed within a general ledger with the purpose of capturing the reduced value of a paired or related account when the two are added together.
  • Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values.
  • That is done by crediting accounts receivable by $100 and debiting the contra revenue account sales returns and allowances for $100.
  • Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount.

Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. By using contra inventory accounts, financial statement users can gain a more accurate and detailed understanding of the company’s inventory position, allowing for better financial analysis and decision-making. This can be anything from products that are for sale to supplies and materials that are needed for production.

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The accumulated depreciation account is perhaps the most common contra asset account used by business owners. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. Accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. 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. The transaction will not impact the income statement as well as the net balance of inventory. Inventory is presented as the net balance which is the combination of inventory cost and allowance for obsolete.

  • So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory.
  • As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts.
  • 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.
  • For its day-to-day operations, the business maintains a fleet of 75 identical 2016 Ford Explorer limousines, each initially retailing at $150 thousand.
  • Write-downs are reported in the same way as write-offs, but instead of debiting an inventory write-off expense account, an inventory write-down expense account is debited.
  • And when your business still has some of these outdated, unwanted, or unusable items in your inventory, you’ll want to offset the lost value of these assets in your general ledger and balance sheet.

Including contra revenue accounts is important in the income statement because it shows the original amount of sales the firm has made, along with any factor that has reduced that amount. The revenue contra accounts Sales Returns, Discounts and Allowances are subtracted from the main Sales Revenue account to present the net balance on a company’s income statement. Nor would it count as a liability as it does not reflect a future obligation. An inventory reserve is an important part of inventory accounting in GAAP. Tracking a company’s inventory reserve allows that company to make a more accurate representation of its assets on the balance sheet. You may not need to use contra asset accounts right now, but as your business grows, using contra asset accounts will likely become a necessity.


Writing off your obsolete inventory in this manner allows you to expense the cost of the obsolete inventory while also decreasing your current inventory balance using the contra asset account. Some of the most common contra assets include accumulated depreciation, allowance for doubtful accounts, and reserve for obsolete inventory. The company has to record the inventory of obsolete $ 40,000 on income statement.

Contra Asset Journal Entry Accounting

Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. 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. Obsolete Inventory is the amount of inventory that passes the best quality and it will be hard to sell to the customer. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. The main reason is to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback.

Inventory Reserve Explained

Unlike the three previously mentioned contra accounts, contra revenue accounts are not listed in the balance sheet but are written near the top of the income statement. Contra revenue accounts typically offset revenue accounts in a firm’s income statement. They are also helpful for keeping the books balanced and creating a clear trail of financial breadcrumbs for historical review and reporting. For instance, it is common to keep the purchase price of a piece of equipment as a historical cost in the debit asset account when it comes to fixed assets.

In other words, contra accounts are used to reduce normal accounts on the balance sheet. An inventory reserve is an asset contra account that is used to write down the value of inventory. The account contains an estimated charge for inventory that has not been specifically identified, but which the accountant expects to write down the value at which it is currently recorded. There may be a variety of causes for such a write down, such as the obsolescence, spoilage, or theft of inventory.

Fortunately, the seat vendor offered an early payment discount of 5%, meaning that when Show-Fleur paid off its full credit note within the first 30 days, it recouped $30 thousand in savings. A company estimates how much of its inventory will “go bad” based on its past experience, its assessment of current industry conditions, and its knowledge of customer tastes. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting. If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. After the year-end closing, the company has quantified that inventory of $ 5,000 is obsolete, so they destroy them immediately.

By keeping the original dollar amount intact in the original account and reducing the figure in a separate account, the financial information is more transparent for financial reporting purposes. For example, if a piece of heavy machinery is purchased for $10,000, that $10,000 figure is maintained on the general ledger even as the asset’s depreciation is recorded separately. A contra inventory account is especially useful when market prices are lower than inventory costs, which will trigger a lower of cost or market adjustment. It is also useful when inventory is quite old or turnover levels are low. A third possible use for the account is when some of the inventory is no longer listed in the bills of material for current products, and so will not be used.

Example #1: Revenue Contra Account

The purpose of a contra inventory account is to reduce the total inventory value shown on the balance sheet by reflecting specific adjustments, allowances, or write-downs related to the inventory. Accumulated depreciation is a contra asset account used to record the amount of depreciation to date on a fixed asset. Examples of fixed assets include buildings, machinery, office equipment, furniture, vehicles, etc. The accumulated depreciation account appears on the balance sheet and reduces the gross amount of fixed assets. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.

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