Contra-Accounts
An account type that hasn’t been mentioned yet is a contra-account. This is an account that offsets (or counteracts) the balance of another account. Contra-accounts have the opposite sign of the account they offset. For example, a contra-account for an asset will have a credit balance. This offsets the asset’s debit balance.
Contra-accounts are usually associated with amounts that are charged on a periodic basis. One example of this is accumulated depreciation. When a company buys a large fixed asset, they are supposed to slowly decrease its balance over a certain number of years. This is called depreciation. If a company bought a large piece of machinery for $50,000, after the first year they might have to mark down the value to $45,000. After the second year, it might be marked down to $40,000 (and so on). No money is actually spent. These amounts are only recorded on paper so that the company can keep track of its current value. Over the years, all this depreciation eventually grows large enough where the asset’s value on paper is recorded as having a zero balance. Keeping track of how much depreciation has accumulated over the years is stored in a contra-account called Accumulated Depreciation.
Contra-accounts are important to use for two reasons. The first reason is that they contradict something we learned earlier. I said earlier that accounts are grouped within the same numerical grouping and that they all follow the debit and credit rules listed in Table A-1. Even though contra-accounts use the opposite sign, they are always listed right after the account they offset. In the case of the machinery example, the machinery account might have an account number of 1600 and be a debit balance. Its contra-account, accumulated depreciation, will have a credit balance so that it offsets the machinery balance. We want to keep them listed together so it is given an account number of 1650. When you see a contra-account listed on a financial report, remember that it uses the opposite sign of the accounts around it.
The second reason contra-accounts are important is that financial reports often format contra-accounts differently to make them standout. Most accounts are listed just by their account name. Contra-accounts are often listed with the word “Less:” preceding them. In addition to that, sometimes they are indented as a group and a sub-total is displayed. For example, here is how the machinery accounts might be shown on the report.
By changing the formatting of an account and its associated contra-account, the reader can scan the report and immediately notice which accounts use contra-accounts and see their current balance. When you design financial reports you’ll have to be on the lookout for contra-accounts and put in special rules to format them appropriately. We’ll practice this in a tutorial later in the appendix.
