We’ll also touch on related topics like gross vs. net profit, prepaid expenses, and unearned revenue. The sales allowances account is similar in use to the sales returns account, except that it deals with allowances given against a defective product which the customer has kept and not returned to the business. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold.

These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, can i deduct private mortgage insurance for these three, the debit balance actually represents a negative amount. To illustrate the contra revenue account Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit.

1. The account is normally a debit balance and in use is offset against the revenue account which is normally a credit balance.
2. Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales.
3. But these items don’t retain that initial value; if liquidated, they would likely be sold at a loss.
4. A business called Show-Fleur offers private driving tours of local botanical gardens — all from the comfort of high-end limousines.

Instead, you need to record this value gap, and a contra asset account serves that purpose. Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. A contra revenue account is a revenue account that is expected to have a debit balance (instead of the usual credit balance). In other words, its expected balance is contrary to—or opposite of—the usual credit balance in a revenue account.

It is not classified as a liability since it does not represent a future obligation. The main advantage of using separate contra revenue accounts is that each one provides targeted information about the individual deductions taken from sales. Since each of these deductions directly reduces your profits, it makes sense to research them in detail, to see if there are any actions that can be taken to reduce the number of deductions. For example, this analysis might indicate that your business has product quality problems or servicing issues that can be corrected.

Sales Allowances

Generally in the financial statements the revenue account would be offset against the contra revenue account to show the net 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 hottest retail item of today can be relegated to nostalgia channels on YouTube tomorrow. 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.

Sales Discounts

And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand.

At the same time, our Accounts Receivable Automation software and Accounts Payable Automation software makes tracking, managing, and processing crucial assets and liabilities — and their contras — easier than ever before. A contra account is an asset account that is kept at either a negative or zero balance and is used on a balance sheet to offset the positive balance of a paired asset. 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. A contra account is an entry on the general ledger with a balance contrary to the normal balance for that categorization (i.e. asset, liability, or equity).

In reality, the actual number of company discounts came closer to $5 thousand. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. Look at contra revenue management as a key part of your broader financial strategy. Focusing on these areas can help your business not only survive, but thrive, in today’s competitive market. Speaking of which, make sure you keep an eye on your competitors and industry best practices. If your allowances or discounts are out of step with industry norms, you might be either giving away too much or not enough to attract customers.

Taking a closer look at contra asset accounts

For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. This type of account could be called the allowance for doubtful accounts or a bad debt reserve.

Contra Account Example: Allowance for Doubtful Accounts

Nor would it count as a liability as it does not reflect a future obligation. These deductions, which come in the form of sales returns, allowances, and discounts, are not expenses but adjustments that lower the total sales on your income statement. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in accounting profit vs normal profit its income statement for the month. If accounts receivable is $40,000 and allowance for doubtful accounts is $4,000, the net book value reported on the balance sheet will be $36,000.

The difference between an asset’s account balance and the contra account balance is known as the book value. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. To compensate for those potential deadbeat customers, you can use a Bad Debts account to serve as a contra for your A/R. Consider a business that offers an early payment discount to its customers, cutting their invoiced total by 3% if they pay within 1 week of invoicing. If every single buyer had taken advantage of the early payment discount, the company would have provided roughly $10 thousand in discounts during that same timeframe.

While both affect your net income, they do so in different parts of your income statement. Contra revenue accounts appear near the top of the income statement, as a deduction from gross revenue. If the amounts of these line items are minimal, they may be aggregated for reporting purposes into a single contra revenue line item. A sample presentation of contra revenue appears in the following exhibit, which contains the revenue-related line items found at the top of an income statement.

When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. There are two major methods of determining what should be booked into a contra account. A contra account provides missing context by pairing it with a related account.

Contra equity reduces the total number of outstanding shares on the balance sheet. The key example of a contra equity account is Treasury stock, which represents the amount paid to buyback stock. The Notes Receivable account documents the total value of any promissory notes held by the company. To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value.