Define Contra Revenue Account
Contra is a Latin word for against or the opposite. The term contra account can be defined as an account linked with another account and having an opposite normal balance, reported as a subtraction from the other account’s balance. Remember, contra accounts never exist on their own, and we always link them to another account. For example, Allowance for Bad Debt is a contra account to Accounts Receivable. Since the Accounts Receivable has a normal debit balance, the Allowance for Bad Debt will have a normal credit balance.
There are several types of contra accounts that correspond to different sections of the financial statements:
- Contra Asset account (credit balance)
- Contra Liabilities account (debit balance)
- Contra Equity account (debit balance)
You would use contra accounts in instances where you want to show the net effect of two separate accounts on financial statements. You can usually observe a pattern: Gross amount–Contra account amount = Net amount. Contra accounts make it easy to retrieve important information, such as asset depreciation, sales returns, and discounts.
A contra revenue account is a type of account that offsets a revenue account on the income statement. There are three common contra revenue accounts:
- Sales returns: If the customer returns the purchased product because it is defective or does not meet the customer’s expectations or requirements.
- Sales allowances/Rebates: Customers find the product damaged or defective, but still usable, and the seller reduces the price if the customer is willing to keep the product.
- Sales discounts: Cash, trade, quantity, or seasonal discounts given to customers, which is usually given to motive the customer to purchase and/or pay early.
We consider these accounts a contra revenue account because they reduce the net sales revenue. Companies use a contra account, instead of debiting Sales Revenue, to disclose the amount of sales returns, allowances, and discounts in the general ledger and the income statement. They include contra accounts with other revenue accounts on the general ledger.
Examples of Contra Revenue Accounts
Assume that an $800 product X-Mart sold on October 6 is defective, but the buyer decides to keep it because X-Mart offers a $150 price reduction. The seller would record the reduction revenue as follows:
If the customer rejected this price reduction and decided to return the defective product, then the seller would make the following journal entry:
So, you will not debit the Sales Revenue account when someone returns something, and you always credit Sales Revenue. To calculate the Net income, the seller would subtract the Sales Returns and Allowances amount from the Gross income.
Let’s review another example. Smith’s factory store’s credit card sales were $4,500 on December 15. The credit card company charges a 2.5% service fee. The credit card discounts are reported as a contra revenue account.
Is Unearned Revenue a Contra Account?
We can define unearned revenues as a payment received by a company from its customers for products or services in advance. This means that you have an obligation before the customer and still need to provide the service or deliver the product since you owe the work in the future, which is why unearned revenue is a liability account.
You will earn the unearned revenue when you deliver the products or services later. The business will repay this cash received from the customer if it fails to fulfill its obligation before the customer. Thus, Unearned Revenue is not a contra account to Revenue because it is just a current or long-term liability a business can have.