What is Contract Liability? Definition, Example, Calculation, and Classification
December 14, 2022
Allowance for doubtful accounts is netted from the accounts receivable balance. 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. A https://online-accounting.net/ account is one that is debited in order to offset a credit to another liability account.
In a sales returns and allowances contra revenue account, you offset the balance in the sales revenue account. When the contra account reads $500 and the normal credit balance is $100,000, then your net sales are $99,500. This indicates that out of $100,000 sales, your customers return goods valued at $500. A contra account is a negative account that is netted from the balance of another account on the balance sheet. 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. When a contra asset account is first recorded in a journal entry, the offset is to an expense.
Contra Liability Account: What it is, How it Works, Example
In this general sense, it’s important to distinguish between the different remedies available to an aggrieved party, or in other words, the party entitled to the payment, reimbursement, or performance. In M&A transactions, such as a leveraged buyout (LBO), financing fees are another example of a contra liability. The main reason is types of assets to make the remaining shares more valuable, as their prices are expected to rise after the stock buyback. Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values. Examples of deferred unearned revenue include prepaid subscriptions, rent, insurance or professional service fees.
- Accounts receivable is rarely reported on the balance sheet at its net amount.
- To oppose the revenue made by a company, contra revenue accounts must have a debit balance.
- Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values.
- Let’s go over how they work and what the main types are, and then finish with an example.
- Revenue is an income statement account, but it flows through to the equity section of retained earnings as well.
Or, if the contra liability account balance is immaterial, the accounting staff could elect not to keep a balance in the account at all. When the amount is material, the line item is typically presented separately on the balance sheet, below the liability account with which it is paired. However, that $1.4 billion is used to reduce the balance of gross accounts receivable. Therefore, contra accounts, though they represent a positive amount, are used to net reduce a gross amount. For this reason, contra accounts are primarily seen as having negative balances because they are used to reduce the balance of another account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean.
Financing fees refer to the payments issued to the 3rd parties engaged when arranging debt financing, i.e. the administrative costs charged by the lender, lender legal fees, etc. Suppose a bond is issued at a discounted price – i.e. lower than the redemption price (or the stated “par value”). Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.
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. A liability that is recorded as a debit balance is used to decrease the balance of a liability. Contra liability accounts are a type of account in financial accounting that offset the balance of corresponding liability accounts.
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What Is the Benefit of Using a Contra Account?
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. Note that the contra liability account has a positive balance (a debit balance), and the liability account normally has a credit balance.
When the company pays the cost of having the flyer printed, a journal entry is done. The purpose of the Owner’s Withdrawal account is to track the amounts taken out of the business without impacting the balance of the original equity account. A delivery van is purchased by a business to use in delivering product and picking up materials. The company uses Straight-Line Depreciation to track the loss of value of the asset over time. However, if the project spans a longer time duration, in that case, contract liability might also be treated as a Non-Current (or Long-Term) liability. Therefore, contract liability mostly results whenever a customer pays in advance, or some parts of the service contract need to be fulfilled.
Example of a Contra Liability Account
Accounts receivable is rarely reported on the balance sheet at its net amount. Instead, it is reported at its full amount with an allowance for bad debts listed below it. Maybe more importantly, it shows investors and creditors what percentage of receivables the company is writing off. It decreases other liabilities on the balance sheet by offsetting a credit to another with which it is paired (as liabilities typically carry a credit balance).
Allowance for uncollectible accounts, or allowance for doubtful accounts, is one of the most common contra current asset accounts. The dollar balance in the allowance for uncollectible accounts is the amount you don’t expect to collect, and this offsets the amount you report in accounts receivable. Are you looking for a way to account for accumulated depreciation, returned merchandise, or damaged inventory?
What You Need to Know About Contra-Liability Accounts
In case the CA account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed. Make sure that you report contra accounts on the same financial statement as the related accounts. If you’re the one managing your company’s books of accounts, be sure to report the contra account on your financial statement on the line item directly beneath the main account.
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This means that when a company incurs an expense but does not pay for it immediately, it records the expense as a credit to the Accrued Expenses Payable account. The contra-liability account for Accrued Expenses Payable is “Accrued Expenses,” which has a debit balance. A contra liability account is a liability account that is debited in order to offset a credit to another liability account. The contra liability account is used to adjust the book value of an asset or liability. When recording an entry into the contra liability account, the typical entry rules are reversed; adding to the contra account is a debit, whereas an addition to the liability account is typically a credit. Whereas assets normally have positive debit balances, contra assets, though still reported along with other assets, have an opposite type of natural balance.
Another term you could encounter in a business setting is contract assets. So, what’s the difference between contract assets and contract liability. To understand this difference, it’s important to distinguish between contract liability in a legal sense and contract liability in an accounting sense.
Hence, the company will have gross revenue or net sales equal to $9,900. For example, when a line item on your balance sheet presents the balance of accounts receivable, report the value of allowance of uncollectible accounts below the accounts receivable line. Be sure to enter the contra account on the opposite column of the account they’re offsetting. If contra assets appear in the credit column, record contra liabilities on side.
Hence, the book value of the liability will be the credit balance of the liability account minus the debit balance of its contra liability counterpart. As mentioned, CA 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.