If the bond is sold at a discount, the company will record the cash received from the bond sale as “cash”, and will offset the discount in the contra liability account. 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. For example, accumulated depreciation is a contra asset that reduces the value of a company’s fixed assets, resulting in net assets.
- Financing fees refer to the payments issued to the 3rd parties engaged when arranging debt financing, i.e. the administrative costs charged by the lender, lender legal fees, etc.
- Let’s go over how they work and what the main types are, and then finish with an example.
- Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.
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The amount is reported on the balance sheet in the asset section immediately below accounts receivable. In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. 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).
Contra revenue accounts reduce revenue accounts and have a debit balance. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset. Contra asset accounts include allowance for doubtful accounts and accumulated depreciation. A key example of contra liabilities includes discounts on notes or bonds payable.
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Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean. The allowance for doubtful accounts – often called a “bad debt reserve” – would be considered a contra asset since it causes the accounts receivable (A/R) balance to decline. 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.
Examples of words with this prefix include ‘contrafissure’, ‘contrasty’, ‘contraprops’, ‘contrasted’, and ‘contravindication’. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services. Home Depot also devotes https://simple-accounting.org/ footnote 4 to its share repurchase program and reports that the company is authorized by its board to repurchase $20 billion in shares. The OID is calculated as the difference between the redemption price and the discounted issuance price.
There can be hidden value in stocks that have a lot of fully depreciated buildings. Companies like to depreciate assets as quickly as possible to get the tax savings, so the balance sheet may not state the true value of fixed assets. If you’re valuing a low-growth company based on its equipment assets, you want to use the net value to be conservative.
Types of contra accounts
The B/S impact is where the contra liability comes into play, i.e. the historical value of the debt is not impacted by the OID. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting. 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. Loans are contractual agreements, so violating a debt covenant represents a breach of a legal contract signed between the borrower and lender(s).
Contra Liabilities Account Definition
Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. Master accounting topics that pose a particular challenge to contradebt finance professionals. We can see how the $10,000 allowance for doubtful accounts offsets the $100,000 A/R account from our illustrative example above (i.e. the account decreases the carrying value of A/R).
List Of 11-Letter Words With The Prefix “contra”
Contra liabilities are common in companies that sell bonds to raise capital. To drum up interest in the bond, the company will sell it at a discount. For example, a bond with a principal amount of $1,000 may be sold for only $950.
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 equity section of the balance sheet is where the shareholder’s claims to assets are reported. The main contra equity account is treasury stock, which is the balance of all stock repurchased by the company. When a company repurchases shares, it increases the fractional ownership of all remaining shareholders. Companies that issue bonds are likely to use contra liability accounts.
Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available. Home Depot reports that returns are estimated at the time of the sale based on historic returns numbers. The amount is not reported, and the net sales amount is reported on the income statement. The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount.
Let’s go over how they work and what the main types are, and then finish with an example. Financing fees refer to the payments issued to the 3rd parties engaged when arranging debt financing, i.e. the administrative costs charged by the lender, lender legal fees, etc. Typically, the lender will also request collateral (i.e. a lien) and/or higher interest rate pricing since the borrower gets to conserve cash and has more time to obtain the required funds. The second type of financial covenants is “incurrence” covenants, which are tested only if the borrower takes a specific action (i.e. a “triggering” event). Financial covenants are imposed to ensure the borrower maintains a certain level of operating performance (and financial health). Affirmative covenants, otherwise called “positive” covenants, require the borrower to perform a certain specified activity – which essentially creates restrictions on the company’s actions.
On the other hand, if you’re looking at a high-flying growth stock that reports new revenue growth records each quarter but has a massive allowance for doubtful accounts, there may be problems ahead. 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. The amortization of the financing fees reduces the pre-tax income (EBT) of the company and the company’s tax burden, i.e. the borrower benefits from these tax savings until the bonds reach maturity. The reason financing fees are an example of a contra liability is that the fees – much like interest on the debt – are amortized over the debt borrowing term. A Contra Liability carries a debit balance rather than a credit balance, which is the opposite of the normal balance carried by liabilities.
Any products that are sold at a discount or returns are deducted from gross revenue to produce net revenue as the top line on the income statement. Home Depot reports net receivables and net property and equipment, implying that both are reduced by contra assets. We’ll need to dig into the footnotes to find out what the contra accounts are.
