Companies report their account balances on the balance sheet. These balances come from an underlying accounting or accumulation of accounts from the financial systems. However, some items may also reduce the total reported amount on these accounts. These items are known as contra accounts in financial accounting. They may relate to several areas in the balance sheet.
What are Contra Accounts?
A contra account relates to a specific area in the balance sheet that includes a negative balance. Companies record the opposite entries for that area in the related contra account. Consequently, these accounts offset the balances related to the original account. Contra accounts link or connect to a paired account which they impact directly.
A contra account reduces the reported balance for the paired account. Therefore, this account is the opposite of the amount reported in the original account. For example, assets usually constitute a debit balance on the balance sheet. A contra asset account includes a credit balance that reduces the amount reported for those assets. However, this account does not appear on its own on the balance sheet.
What are the types of Contra Accounts?
Contra accounts relate to all areas of the balance sheet. These include assets, liabilities, and equity. As mentioned above, these accounts also pair with a paired account and reduce its carrying balance. The three types of contra accounts are as below.
Contra asset account
Asset accounts are debit balances on the trial balance and the balance sheet. However, contra asset accounts constitute a credit balance. These items decrease the asset balance on a corresponding account. For example, accumulated amortization is a contra asset account that reduces the balance for intangible assets. Contra asset accounts are the most common type of contra account.
Contra liability account
Liability accounts are credit balances on the balance sheet. However, contra liability accounts are debit balances. These items decrease the liability balance on the paired liability account. For example, a discount on bonds is a type of contra liability account. This account reduces the balance reported for bonds on the balance sheet.
Contra equity account
Equity is a credit item on the balance sheet. Similarly, its underlying balances also appear on the credit side of the trial balance. However, a contra equity account is a debit balance that reduces the balances reported on equity accounts. For example, treasury stock is a common type of contra equity account. It does not appear on the balance sheet. However, it reduces the reported equity for a company.
What is the importance of Contra Accounts?
Contra accounts are crucial in reducing the balance on the paired account. Companies can record these transactions in the related account. However, contra accounts allow them to track these transactions separately. Furthermore, these accounts are also crucial in allowing companies to record the original values for the paired accounts.
Contra accounts are also helpful in recording temporary reductions in the original balances. For example, treasury stock for equity may last for a short time. Therefore, having them separate can ensure companies can track these changes easily. Contra accounts also allow companies to present the net value for these areas by reducing the original amount.
Conclusion
Contra accounts reduce the balance on a paired account in a specific area in the balance sheet. However, these accounts do not appear on the financial statement separately. Contra accounts relate to all areas in the balance sheet, including assets, liabilities, and equity. These accounts are crucial in the financial reporting process, as stated above.
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