What Is a Contra Account? Types + Examples

You can estimate the total to record in the allowance for doubtful accounts based on uncollectible revenue totals from the previous year or you can conservatively estimate the amount. 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). Both the LIFO and FIFO methods fall in line with the Generally Accepted Accounting Principles (GAAP) established by the Financial Accounting Standards Board (FASB) in the US. The goal is to make the presentation of inventory value as attractive as possible. For internal reports, which are viewed by shareholders that benefit from company profit, the FIFO method is typically used because it presents the actual or reasonably expected profit the company stands to generate.

The hottest retail item of today can be relegated to nostalgia channels on YouTube tomorrow. And when your business still has some of these outdated, unwanted, or unusable items in your inventory, you’ll want to offset the lost value of these assets in your general is cost of goods sold a contra account ledger and balance sheet. So rather than adjusting your Inventory account, you would update its contra account — Obsolete Inventory.

Contra inventory account — AccountingTools

The amount is reported on the balance sheet in the asset section immediately below accounts receivable. Since it is a contra asset account, this allowance account must have a credit balance (which is contrary to the debit balances found in asset accounts). Cost of Goods Sold is a prominent line item on a company’s income statement, appearing directly below sales revenue. It is subtracted from sales revenue to calculate gross profit, an important indicator of a company’s profitability from its core operations. This calculation demonstrates how efficiently a company manages its production costs relative to its sales.

For its day-to-day operations, the business maintains a fleet of 75 identical 2016 Ford Explorer limousines, each initially retailing at $150 thousand. However, these vehicles have experienced significant wear and tear in the intervening years. And currently, Show-Fleur anticipates that it could only sell each one for roughly $50 thousand, meaning the depreciation per vehicle is $100 thousand. He just spent $100 on inventory (probably on account, so he now owes AshBats $100). He places three bats on display right inside the front door in a nice rack with some other wooden and aluminum bats, and he puts the other seven in the back storage area. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

Once sales are made, not only sale revenue and account receivable are affected by this transaction. Your COGS includes the steel, rubber, glass, and wages of the workers assembling the cars. The cost of shipping those cars to dealerships or the commissions of the slick salespeople convincing customers they need an upgrade. Rising COGS, due to higher material costs or labor inefficiencies, can erode gross margins, prompting businesses to adjust pricing strategies or pursue cost-saving measures. Companies may negotiate better supplier terms, adopt bulk purchasing, or invest in automation to reduce labor costs.

• The amount is reported on the balance sheet in the asset section immediately below accounts receivable.
• These accounts, which offset regular inventory accounts, help businesses account for losses due to obsolescence, shrinkage, or write-downs.
• Either cash sale or credit, we need to reduce cash or account receivable accounts and reduce the revenues.

Products

Other examples include (1) the allowance for doubtful accounts, (2) discount on bonds payable, (3) sales returns and allowances, and (4) sales discounts. A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance. Two common contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect.

Accounting for costs of goods sold in financial statements:

It carries a credit balance and is linked to the fixed asset account, which carries a debit balance. The accumulated depreciation account is designed to reduce the carrying value of the fixed asset account when depreciation is recorded at the end of each period. 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. Examples of contra liabilities are Discounts on Bonds and Notes Payable and Short-Term Portion of Long-Term Debt.

List of Contra Accounts

Wanting to spruce up its aging inventory, Show-Fleur purchased new, climate controlled-seats for its fleet, delivering increased comfort for passengers and a cleaner, more modern look for vehicle interiors. Let’s say a further direct cost of $200 is incurred on labor, and this gives us a total cost of goods sold of $600 ($200+$400). The weighted average cost method measures the value of the cost of goods sold and closing inventory at a rate such that the cost of total inventory purchased is divided by the total units in the inventory. The other account that will be affected the same amount as finished goods is the cost of goods sold.

Accrual Accounting: Key Principles and Business Implications

• In practice, contra expense accounts are often used in various scenarios, such as purchase returns, allowances, and discounts received.
• As explained, the debit cost of goods sold will increase the cost of goods sold in the income statement, and credit to finish goods will decrease the balance of finished goods in the balance sheet.
• Contra expense accounts come in various forms, each serving a unique purpose in financial accounting.
• These categorizations ensure that financial statements accurately reflect where money comes from, where it goes, and what assets and liabilities a company holds.
• Explore the true nature of key financial entries and their impact on profit reporting and financial statements.

So once this entry is posted, inventory will be increased, and the cost of goods sold will be derecognized. If using a periodic system, you will make adjusting entries to update inventory and COGS at period-end. Now that you’re armed with this knowledge, go forth and conquer your financial statements! Remember, only the costs of goods that were actually sold during the period make it into the COGS calculation. I’ve started learning to account recently, and I have a question about “cost of goods sold”. Next, we’ll take a closer look at the difference between the sales price and the cost of goods sold., But first, check your understanding of the concept of cost of goods sold.

Journal Entries for Sales Return:

One such technique is predictive analytics, which uses historical data and statistical algorithms to forecast future inventory needs and potential losses. By anticipating obsolescence or shrinkage, companies can proactively adjust their inventory levels and minimize the impact on financial statements. Tools like IBM SPSS or SAS Analytics can be instrumental in implementing these predictive models, providing actionable insights that drive better decision-making. Inventory Shrinkage accounts for losses that occur due to theft, damage, or administrative errors. This type of contra account is particularly relevant for businesses with large inventories or those operating in retail environments where such losses are more common.

Therefore, a contra expense account that contains a debit balance must have a negative ending balance. In theory, sellers could record both sales returns and sales allowances as debits to the Sales account because they cancel part of the recorded selling price. However, because the amount of sales returns and sales allowances is useful information to management, it should be shown separately.

If it is not consistent, then the cost of goods sold and revenues will be recognized in the financial statements in a different period. And it is not in compliance with the matching principle, resulting in the over or understated profit during the period. As explained, the debit cost of goods sold will increase the cost of goods sold in the income statement, and credit to finish goods will decrease the balance of finished goods in the balance sheet. The figure for the cost of goods sold only includes the costs for the items sold during the period and not the finished goods that are not still sold or billed by customers. Costs of goods sold vary as the number of finished products increase or decreases. As mentioned above, under the perpetual inventory system, there is an additional entry to record the reduction of cost of goods sold and the increase in merchandise inventory.

These accounts are typically paired with a corresponding expense account, allowing for a more detailed and accurate representation of financial activities. For instance, if a company receives a rebate on a previously recorded expense, the rebate would be recorded in a contra expense account, effectively reducing the total expense reported. The Notes Receivable account documents the total value of any promissory notes held by the company. To obtain a cash payout before the note reaches maturity, you can sell these notes to a bank or other financial institution for some price below the note’s face value.

Is Cost of Goods Sold a Contra Account?

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. For the seller, revenue can be revised by debiting the sales return account (A contra account by nature) and crediting cash/accounts receivable with the invoice amount. For example, an asset was purchased by a company for $100,000 – that is, the historical cost of the asset was $100,000 – and its contra asset counterpart has a balance of $30,000. If the inventory write-off is immaterial, a business will often charge the inventory write-off to the cost of goods sold (COGS) account. The problem with charging the amount to the COGS account is that it distorts the gross margin of the business, as there is no corresponding revenue entered for the sale of the product. A large inventory write-off (such as one caused by a warehouse fire) may be categorized as a non-recurring loss.

The most common contra type, contra assets, records the loss in value of any asset accounts listed in your general ledger. And by comparing these contras against their corresponding parent accounts, you can better understand the actual value of the assets retained by your business. Because contra asset accounts are used so frequently, it’s worth spending a little bit more time on them here, including common subtypes. The Allowance for Doubtful Accounts is directly related to the asset account entitled Accounts Receivable.