Since we are now discussing returns and allowances, can you figure out what account we will use? Most of the time in accounting, the account names describe what is going on. So let’s look at the entry for the same transaction under periodic inventory. Inventory refers to assets owned by a business to be sold for revenue or converted into goods to be sold for revenue. Generally accepted accounting principles (GAAP) require that any item that represents a future economic value to a company be defined as an asset.

While tracking contra asset accounts is cumbersome for bookkeepers and accounting clerks using manual accounting systems, if you’re using accounting software you’ll find that most of the heavy lifting is done for you. If you offer credit terms to your customers, you probably know that not all of them will pay. Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Anytime you need to depreciate an asset, you’ll use an accumulated depreciation contra asset account, which records the amount of depreciation that has been expensed while offsetting the value of the asset being depreciated. Allowance for doubtful accounts (ADA) is a contra asset account used to create an allowance for customers who are not expected to pay the money owed for purchased goods or services.

Accounting Terms: V

A contra account provides missing context by pairing it with a related account. So as values shift depending on real-world factors, rather than making deductions or adjustments to the original or “parent” account, you would record these changes in the contra account instead. By viewing these accounts — the parent and contra — in tandem, business owners can gain broader insights, preserve the historical figures stored in the parent account, and make accommodations for any relevant changes. By accounting industry standards, inventory reserve is a conservative methodology. It attempts to predict inventory losses even before a loss has been confirmed to have happened. As such, inventories are made up of goods that have future economic value, which qualifies them as assets.

The accumulated depreciation account has a credit balance and is used to reduce the carrying value of the equipment. The balance sheet would report equipment at its historical cost and then subtract the accumulated depreciation. Contra revenue is a general ledger account with 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. 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.

Example of a Contra Inventory Account

ABC International’s controller decides to maintain a 3% inventory reserve, based on the company’s historical experience with inventory losses. This amounts to a $30,000 debit to the cost of goods sold, and a $30,000 credit to the inventory reserve contra account. The company later identifies $10,000 of obsolete inventory; it writes down the value of the inventory with a $10,000 debit to the inventory reserve contra account and a credit to the inventory account. As mentioned, contra asset accounts are usually listed below their matching asset accounts, and the net values of those assets are written next to the contra accounts. Contra equity accounts are accounts in the equity section of the balance sheet that reduce the amount of equity a company holds. Therefore, contra equity accounts have a debit balance to offset their corresponding equity balances.

The Contra Liability Account

A return occurs when inventory is purchased and later returned to the seller. This transaction has an effect on inventory for both the seller and the buyer, because inventory is physically moving. Remember, the rules for perpetual and periodic inventory still apply so we will look at both cases here.

Inventory Reserve Defined: How to Use in Accounting

This means it received $4,500 in cash but needs to pay $5,000 back to the bondholders. I am new to accounting and need to make Chart of Account for an Inventory Management Information System. On August 16, Medici Music discovers that two of the flutes it ordered from Whistling Flutes, LLC were slightly scratched. Whistling Flutes agreed to discount the flutes by $200 and Medici agreed to keep the flutes.

This might involve using software to track inventory levels, or it could be as simple as keeping a physical count of what is on hand. You could commit a minor amount of reporting fraud by increasing the size of the inventory reserve during profitable periods and using this inflated reserve to draw down the balance when you need to increase reported profits. This sort of behavior is not condoned, and may be spotted by auditors who want to see a valid justification for any unusual changes to the reserve. In this way, the historical cost, the amount of write-off, and the book value of an asset can always be seen on the balance sheet.

Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation. Contra liability accounts are less commonly used than contra asset accounts.

Allowance for doubtful accounts is contra asset accounts that offset the accounts receivable. They are used in case some customers won’t be able to pay the money they owe to the business. Both the asset and the corresponding contra asset accounts must be stated clearly in the balance sheet. Usually, the asset account is listed first, and its contra asset counterpart is listed underneath, with the asset’s net value or book value. Note that in accounting, the term “book value” is also used interchangeably with net value.

As mentioned, contra asset accounts usually have a negative value which is the same as a credit balance. That is to completely or partially offset the balance of their related asset accounts. Asset accounts usually have a positive value which is the same as a debit balance. Far less common is the obsolete inventory reserve, which reduces the overall inventory value on the balance sheet.