In other words, contra revenue is a deduction from gross revenue, which results in net revenue. The sales allowance shows the discounts given to customers when returning the product. Let’s consider a fictional example of a small retail business called “GadgetHub” to illustrate the use of a contra expense account in financial accounting. From the table above it can be seen that assets, expenses, and dividends normally have a debit balance, whereas liabilities, capital, and revenue normally have a credit balance.

When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. To account for this, accountants have to estimate non-payments with the use of doubtful accounts. Accounts receivable is an asset and has a debit balance, so doubtful accounts have a credit balance. (Remember, allowances are always the opposite of the account they are linked to!) Accounts receivable on the balance sheet is shown net of the allowance for doubtful accounts and is reported as net accounts receivable. In this example, the contra expense account (Purchase Discounts) is used to provide a more accurate and detailed representation of the company’s expenses, allowing for better financial analysis and decision-making.

Purchase Return, Allowance, and Discount Contra Expense Accounts

When a company gives a discount to customers in an effort to convince them to buy its goods or services, it is recorded in the discount on sales account. A contra account is a general ledger account with a balance that is the opposite of another, related account that it is paired with. 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.

This of course will reduce the seller’s accounts receivable and is subtracted from sales (along with sales discounts) to arrive at net sales. Gross sales revenue is the revenue earned through selling products intended for sale before relevant deductions such as sales discounts, returns and allowances (price deductions) occurred. Gross sales revenue is calculated as being equal to the number of products sold multiplied by the price at which they are sold. The allowance for doubtful accounts reduces the gross balance of accounts receivable down to an estimated recoverable balance in accordance with the conservatism principle. Purchases will normally have a debit balance since it represents additions to the inventory, an asset. The contra account purchases returns and allowances will have a credit balance to offset it.

Although each account has a normal balance in practice it is possible for any account to have either a debit or a credit balance depending on the bookkeeping entries made. On the income statement, the net cost of goods sold will be reported as $98,000 ($100,000 – $2,000), reflecting the impact of the purchase discount. Since the purpose of the contra account is to be offset against the balance on another account, it follows that the normal balance on the contra account will be the opposite of the original account. Only enter cash paid to credit suppliers when the cash is used to make a payment towards an invoice.

For example, if a business sold 200 units of its product at $800 each, that business has made $160,000. Notice bad debt expense does not change when the accounts receivable has been written off. The loss on the uncollectible receivable had already been anticipated when establishing the allowance.

Purchase Discount in Accounting

If a firm sells a high volume of a product on credit, it is likely that some of its customers will not be able to pay their credit payment. In this case a liability (accounts payable) decreases as the amount owed to the supplier is reduced by the purchases allowance credit note, this reduction is balanced by the increase in owners equity. The credit to the income statement for the purchases allowance increases the net income which increases the retained earnings and therefore the owners equity in the business.

For example net sales is gross sales minus the sales returns, the sales allowances, and the sales discounts. The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts. The balance sheet would report equipment at its historical cost and then subtract 7. the contra account purchases discount has a normal debit balance. the accumulated depreciation. A contra liability is a general ledger account with a debit balance that reduces the normal credit balance of a standard liability account to present the net value on a balance sheet.

• 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.
• Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting.
• A company might decide to purchase its stock when the board of directors feel the stock is undervalued or when it wishes to pay its shareholders dividends.
• Net sales is equal to gross sales minus sales returns, allowances and discounts.

Accounting Ratios

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

Verification of Accounting Records

The amount in allowance for doubtful accounts is deducted from the accounts receivable account of a company. 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 cost of goods sold (COGS) account will have a debit balance of $100,000, representing the initial cost of the inventory. The purchase discounts account will have a credit balance of $2,000 (2% of $100,000), which represents the discount received from the supplier. For example, a purchaser brought a $100 item, with a purchase discount term 3/10, net 30. If he pays half the amount In accounting, gross method and net method are used to record transactions of this kind.

Examples of revenue contra accounts are Sales Discounts, Returns and Allowances. Contra liability accounts such as discount on bonds payable and discount on notes payable usually carry debit balances. This depreciation is saved in a contra asset account called accumulated depreciation. The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment. So for example there are contra expense accounts such as purchase returns, contra revenue accounts such as sales returns and contra asset accounts such as accumulated depreciation. Revenues are what businesses earn through selling their products to their customers while expenses are what businesses spend in the course of running their operations.

Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups. The discount on bonds payable amount shows the difference between the amount of cash received when issuing a bond and the value of the bond at maturity. The allowance method of accounting enables a company to determine the amount reasonable to be recorded in the contra account.

• Purchase returns, allowances and discounts are all examples of contra expense accounts.
• Contra accounts such as these have a debit balance and are deducted from the total amount of a company’s revenue.
• Bill uses the purchases returns and allowances account because he likes to keep tabs on the amount as a percentage of purchases.
• The company must publish its financial information at the end of the month or quarterly–far sooner than ninety days.
• Debit simply means on the left side of the equation, whereas credit means on the right hand side of the equation as summarized in the table below.

As a result, its November income statement will be matching $2,400 of bad debts expense with the credit sales of $800,000. If the balance in Accounts Receivable is $800,000 as of November 30, the corporation will report Accounts Receivable (net) of $797,600. A contra expense account is a type of account in financial accounting that offsets the balance of a corresponding expense account. Contra expense accounts have a credit balance, which is the opposite of the typical debit balance found in expense accounts.

Contra accounts are more commonly paired with asset accounts, such as accounts receivable or inventory, to reduce the carrying values of those assets. A liability that is recorded as a debit balance is used to decrease the balance of a liability. It is not classified as a liability since it does not represent a future obligation. Including contra accounts on a balance sheet is important as it allows for a more transparent view of a company’s financial position. A purchase discount is a small percentage discount a company offers to a buyer to induce early payment of goods sold on account. When a buyer pays the bill within the discount period, accountants debit cash and credit accounts receivable.

This can help anyone viewing the financial information to find the historical cost of the asset. The accumulated depreciation amount shows how much depreciation expense has been charged against an asset. Accumulated depreciation decreases the value of an asset, bringing it more in line with its market value.

For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. Our team of reviewers are established professionals with years of experience in areas of personal finance and climate. Carbon Collective partners with financial and climate experts to ensure the accuracy of our content. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.

Business Documents

For this reason the account balance for items on the left hand side of the equation is normally a debit and the account balance for items on the right side of the equation is normally a credit. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees.