A contra account is a ledger account used to hold an ancillary balance of a major income statement or balance sheet item. Most often the balance of the contra account is exactly opposite to the balance of the associated parent account.
In an accounting system, ledger accounts are designed to contain only similar transactions and/or balances. A separate account is needed whenever the nature of transactions changes. It is because clubbing together dissimilar transactions impedes any analysis. For example, we need separate accounts to hold the actual cost of property, plant and equipment (PPE) and related accumulated depreciation. If we record depreciation expense in the cost accounts directly, we will lose key information about the original cost of the assets and accumulated depreciation. To avoid this loss of important data, we record actual cost and depreciation in separate ledger accounts.
For the purpose of presentation on primary financial statements, we are often concerned only with the net figure of two similar classes/balances which we determine by subtracting one account from the another. For example, it is not very useful to show the PPE cost account and the related accumulated depreciation account separately on the balance sheet. We are better off subtracting the accumulated depreciation account (the contra account) from PPE cost account (the parent account) to arrive at the net balance of the PPE.
List of common contra accounts
As evident from the table below, each contra account has a parent account whose normal balance is often exactly opposite of the normal balance of the relevant contra account.
|Contra Account||Parent Account||Normal Balance of Parent Account||Normal Balance of Contra Account|
|Provision for bad debts||Accounts receivable||Debit||Credit|
|Accumulated depreciation||Fixed assets||Debit||Credit|
|Treasury stock||Common stock||Credit||Debit|
|Discount on bond payable||Bonds payable||Credit||Debit|
Sometimes, we have an ancillary balance whose normal balance is the same as that of the parent account. For example, we need to keep the face value of a bonds payable and the premium amount in separate ledger accounts even though both have credit balances. A separate account used in such a situation is sometimes called a adjunct account.
by Obaidullah Jan, ACA, CFA and last modified on