Contra Liability Account: What it is, How it Works, Example

Contra accounts exist when the account reported on the balance sheet needs to be reduced by a different account to show its true value. For example, GAAP accounting (or generally accepted accounting principles) requires fixed assets to be reported at cost on the balance sheet, but, over time, that value depreciates as the assets are used. The balance sheet will show a gross fixed assets value, a contra account value for accumulated depreciation, and a net value. All three values can be useful for investors depending on what they’re looking for. A liability that is recorded as a debit balance is used to decrease the balance of a liability. Contra Liability a/c is not used as frequently as contra asset accounts.

With that said, debt covenants are NOT intended to place an unnecessary burden on the borrower or hinder their growth with strict restrictions. Debt covenants are defined as requirements and/or conditions imposed by the lender and agreed upon by the borrower during the arrangement and finalization of a financing package. The words arranged in the lists below are in order of frequency of use, from left to right and down. This article page contains a comprehensive list of words with the prefix ‘contra’.

  1. A debit will be made to the bad debt expense for $4,000 to balance the journal entry.
  2. The allowance for doubtful accounts is not specifically reported, but the 10(K) reported that the allowance is immaterial to the amount.
  3. Accumulated depreciation reflects the reduction in value of a fixed asset.
  4. 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.
  5. Still, the dollar amounts are separately broken out in the supplementary sections most of the time for greater transparency in financial reporting.

If a company violates a covenant, the company is in “technical default,” with consequences that could range from the breach being “waived” by the lender to the lender bringing the issue to Court. Compliance for incurrence covenants is not tested regularly, yet the lender would likely prefer not to test for potential breaches constantly. Since covenants help protect against potential downside, the imposition of covenants allows lenders to present more favorable terms to prospective borrowers. Covenants are conditional terms in lending agreements to ensure the borrower’s financial performance remains steady and management continues to be responsible when making corporate decisions.

The company predicts which accounts receivable won’t be paid by customers and writes those off. When the account receivable is written off, it is added to bad debt expense on the income statement and placed in the contra account. If a company has a high or fast-growing allowance as a percentage of accounts receivable, keep a close eye on it. As you saw in the example, contra accounts can be an important part of your financial statement analysis, but they are hard to find.

Understanding Contra Liability Accounts

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. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. 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.

Contra Liability Account: What it is, How it Works, Example

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. 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. This type of account could be called the allowance for doubtful accounts or a bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.

Companies bury them in the footnotes and often don’t break out the actual calculation. Still, it is important when possible to consider how the net accounts are calculated and https://simple-accounting.org/ be wary of companies that are reporting a ton of bad debts. Revenue is an income statement account, but it flows through to the equity section of retained earnings as well.

List Of 12-Letter Words With The Prefix “contra”

Contra liability, equity, and revenue accounts have natural debit balances. These three types of contra accounts are used to reduce liabilities, equity, and revenue which all have natural credit balances. Therefore, for these three, the debit balance actually represents a negative amount. A contra account is a negative account that is netted from the balance of another account on the balance sheet.

The first contra liability listed is an original issue discount (OID), a feature of debt financing wherein the issuance price is less than the redemption price. The net amount – i.e. the difference between the account balance post-adjustment of the contra account balance – represents the book value shown on the balance sheet. The difference between an asset’s account balance and the contra account balance is known as the book value. Accumulated depreciation is the total of all depreciation that has been charged to existing fixed assets such as equipment and buildings.

There are numerous types of restrictive covenants that tend to be company-specific, but the recurring theme is that they often limit the amount of total debt the company can raise. In fact, borrowers can benefit from debt covenants by receiving more favorable debt pricing – e.g. lower interest rate, less principal amortization, waived fees, etc. contradebt – and forced operational discipline. In footnote 3, the company reports, “Net property and equipment includes accumulated depreciation and amortization of $25.3 billion as of August 1, 2021 and $24.1 billion as of January 31, 2021.” Contra accounts are confusing at first, but, with a little study, understanding them becomes second nature.

The two most common contra accounts are the allowance for doubtful accounts/bad debt reserve, which is subtracted from accounts receivable, and accumulated depreciation, which is subtracted from fixed assets. Key examples of contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Accumulated depreciation reflects the reduction in value of a fixed asset. 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 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.

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This make sense because Home Depot wouldn’t be carrying accounts receivable with long payment terms. Most accounts receivable would just be the time between purchase and credit card settlement. In M&A transactions, such as a leveraged buyout (LBO), financing fees are another example of a contra liability. In terms of the journal entries, the debit balance in “Discount on Bonds Payable” is subtracted from the credit balance in the “Bonds Payable”. Accounts receivable (A/R) has a debit balance, but the allowance for doubtful accounts carries a creditbalance. Word Lists was created to provide comprehensive and useful word lists, together with language articles and word tools to help students and anyone learn and understand the English language.

How Does a Contra Account Work in Accounting?

The difference between an asset’s balance and the contra account asset balance is the book value. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance. Last, for contra revenue accounts there are sales discounts, sales allowances, or sales returns. These contra revenue accounts tend to have a debit balance and are used to calculate net sales. A contra liability is an account in which activity is recorded as a debit balance and is used to decrease the balance of a liability. Allowance for doubtful accounts is netted from the accounts receivable balance.

It is not classified as a liability since it does not represent a future obligation. In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account. In other words, the contra liability account is used to adjust the book value of an asset or liability. Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.

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