What is a Contra Liability?

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. For example, if the balance of accumulated depreciation increases from $20,000 to $50,000, this means that the depreciation expense amounts to $30,000, which will be listed in the income statement. Note that the asset account balance represents the purchase price of the asset in question, also known as its historical cost. Sometimes, it is important to keep the original balance of the accounts and create the contra accounts to be able to calculate the net value of the account.

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. Contra liability accounts are less commonly used than contra asset accounts. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable.

What is Variable Expense?

In accordance with the Revenue Recognition Principle, organizations are only supposed to record revenues when they have been ‘earned’. This implies that revenues should be recorded only when they work against the service contract has been fulfilled. Contract Liabilities mostly occur in the case of contracts that span across a relatively larger time span. It is important to understand the fact that contract liabilities are mostly relevant for industries that involve one-off orders. Do you have any questions about contract liability and want to speak to an expert?

• Each year of an asset’s life, another year of Depreciation Expense is recorded.
• You can use contra accounts to record the goods your customers return, inventory that gets damaged, and equipment depreciation.
• For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account.

These contra revenue accounts tend to have a debit balance and are used to calculate net sales. If there’s an increase to allowance for uncollectible accounts, you record the same amount in the bad debt expense of your income statement. Similarly, accumulated depreciation accounts reduce the value of the fixed assets you report on your financial statements. Contra revenue is a general ledger account with excel cash book a debit balance that reduces the normal credit balance of a standard revenue account to present the net value of sales generated by a business on its income statement. Examples of revenue contra accounts are Sales Discounts, Returns and Allowances. Contra Liability Account – A contra liability account is a liability that carries a debit balance and decreases other liabilities on the balance sheet.

Examples of Common Contra-Liability Accounts

For example, if your business has accounts receivable of $50,000 and an allowance for doubtful debts account totalling $5,000, the net accounts receivable is $45,000. In this way, a contra asset (credit) lowers the overall value of your accounts receivables (debit) on the balance sheet. The contra equity account treasury stock is reported right on the balance sheet. Home Depot has repurchased more than $72 billion of stock to date, with around $7 billion coming during this accounting period. 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.

• Hence, the company will have gross revenue or net sales equal to $9,900.
• The credit balance in the contra inventory account will be combined with the debit balance in the inventory account when a balance sheet is prepared.
• Accumulated depreciation reflects the reduction in value of a fixed asset.
• Contra accounts are more commonly paired with asset accounts, such as accounts receivable or inventory, to reduce the carrying values of those assets.

The bond is listed on the balance sheet at the full amount of $1,000, but the cash received is just $950, so a contra liability for the discount is listed to make the entry balance. Properly recording and reporting contra-liability accounts is essential for providing accurate and complete information about a company’s liabilities in its financial statements. This information is critical for investors and creditors who rely on financial statements to make informed decisions. For example, the account “Accrued Expenses Payable” is a liability account that has a credit balance.

Who is Liable in a Contract?

When the balance in the accumulated depreciation is $10,000 and your equipment account has a debit balance of $50,000, then the book value of your equipment is $40,000. By reporting contra accounts on the balance sheet, users can learn even more information about the company than if the equipment was just reported at its net amount. Balance sheet readers cannot only see the actual cost of the item; they can also see how much of the asset was written off as well as estimate the remaining useful life and value of the asset. 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.

In a more specific instance of contract liability as described in our example earlier, the party to whom liability was transferred, would be liable in terms of the contract. Firstly, the aggrieved party could claim damages arising out of the contract. Here, the party will typically be compensated in the amount they would have received had the contract been executed. So, in simple terms, if a contracting party would have earned $10,000 profit had the other party performed its obligations in terms of the contract, it would be entitled to damages in this amount. Keep in mind that this is a simple example and there are many other cases where contract liability could be used by one party to protect itself in a contract. This makes it ideal for businesses because they typically enter into many types of contracts from
employment contracts
to
lease agreements
and
service contracts
with different parties.

How to Record and Report Contra-Liability Accounts on Financial Statements

The contra asset account Accumulated Depreciation is deducted from the related Capital Assets to present the net balance on the parent account in a company’s balance sheet. 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. Therefore, contract liability is created in the case where the customer pays in advance, and the organization still needs to complete the performance obligations for the revenue to be recognized as revenue.

Whenever the balance of an account needs to be reduced in a company’s ledger, it is not always applicable to credit the account if it is an asset or debit the account if it is a liability. Hence, the term valuation account represents all types of balance sheet accounts related to their corresponding balance sheet accounts. This helps the firms to evaluate the book value of their assets and liabilities. The purpose of a contra expense account is to record a reduction in an expense without changing the balance in the main account. This is after the revenue has been ‘earned’ as a result of the delivery of the machines.

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. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation.

A contra account is also known as a valuation allowance, because it adjusts the carrying value of the account with which it is paired. The B/S impact is where the contra liability comes into play, i.e. the historical value https://online-accounting.net/ of the debt is not impacted by the OID. In spite of its name, contra liabilities function more similarly to assets. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.