Contra revenue transactions are recorded in one or more contra revenue accounts, which usually have a debit balance (as opposed to the credit balance in the typical revenue account). There are three commonly used contra revenue accounts, which are noted below. In the sales revenue section of an income statement, the sales returns and allowances account is subtracted from sales because these accounts have the opposite effect on net income.

In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses. Although sales returns and sales allowances are technically two distinct types of transactions, they are generally recorded in the same account. Sales returns occur when customers return defective, damaged, or otherwise undesirable products to the seller.

Understanding a Contra Account

The purpose of a contra account is to accurately report value of operating performance and assets for a firm. A contra account is an account that records events like adjustments and transactions that are having an opposite effect on a relating account’s true value on the firm’s financial statements. If we https://www.bookstime.com/calculating-retained-earnings record those events within the relating account, we risk losing information that is relevant to analyzing performance. Sale on account, which can also be known as a sale on credit or credit sales, refers to when businesses give a product over to a customer and customers do not have to pay until later.

However, if gross revenue is shown it will have the contra-revenue deductions listed below gross revenue, and a subtotal for net revenue below that. Revenue recognition is built on top of a double-entry accounting ledger that tracks debits and credits resulting from your business activity. Balance of such accounts are under debit side, while revenue balances are under credit side. A contra account enables a company to report the original amount while also reporting the appropriate downward adjustment. Brand owners need to manage conflict between their channel partners to ensure long-term engagement from the channel. Deal and design registration programs are examples of contra-revenue programs designed to manage channel conflict.

How to Record a Sales Return for Accounting

If your company has minimal contra revenue activity, it is acceptable to record these transactions within the revenue account. Secondly, as the first item on the income statement, sales revenue is an important line item in the top-down approach of forecasting the income statement (and also why revenue is often known as the “top line”). The historic trend of revenue is analyzed, and revenue for future periods is forecasted. All expenses below sales revenue are often found expressed as a percentage of that revenue.

In case a customer returns a product, the company will record the financial activity under the sales return account. Contra accounts appear on the same financial statement as the related account. For example, an accounts receivable’s contra account is a contra asset account. This type of account can also be called the bad debt reserve or allowance for doubtful accounts. In addition to sales returns, the most common contra revenues are sales discounts and sales allowances.

How to use On Time-In Full (OTIF) as a Competitive Advantage

The first step in identifying such problems is to carefully monitor sales returns and allowances in a separate, contra‐revenue account. To illustrate the contra revenue account Sales Returns and Allowances, let’s assume that Company K sells $100,000 of merchandise on credit. It will debit Accounts Receivable for $100,000 and credit to Sales for $100,000. If a customer returns $500 of this merchandise, Company K will debit Sales Returns and Allowances for $500 and will credit Accounts Receivable for $500. Company K’s income statement will report the gross Sales of $100,000 minus the sales returns and allowances of $500 and the resulting net sales of $99,500. Examples of contra accounts include Allowance for Doubtful Accounts, Accumulated Depreciation, and Return on Sales.

Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. Net sales revenue refers to a company’s total sales revenue in a given fiscal period after subtracting certain items. Gross sales revenue is not adjusted for returns, allowances, and discounts. As asset accounts have debit balances, contra asset account will have credit balance.

Contra Asset Journal Entry Accounting

They serve an invaluable function in financial reporting that enhances transparency in accounting books. When recording assets, the difference between the asset’s account balance and the contra account balance is the book value of the asset. Contra accounts are shown in the financial statements below the paired accounts, although sometimes the balances of the two accounts are merged to a net amount for presentation contra revenue account purposes. The allowance method of accounting allows a company to estimate what amount is reasonable to book into the contra account. The percentage of sales method assumes that the company cannot collect payment for a fixed percentage of goods or services that it has sold. When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value.

A « discount, » in accounting terms, usually refers to a price reduction offered as an inducement to customers who pay their bills quickly, not to a « sale » price, which is simply incorporated into gross revenue. Sales allowances are price reductions offered to persuade customers to accept merchandise with damage or minor defects not serious enough to warrant a return. The amount for estimated uncollectible accounts is a bad debt operating expense. The allowance for doubtful accounts is the contra account that reduces the accounts receivable to an estimated realizable amount. The net accounts receivable will more accurately report your assets on the balance sheet, and the estimated uncollectible expense will recognize the reduction to income in the same period as the sale.

Asset Contra Account

Rebates to the distributor represent 4% of sales, SPIFs for the sales reps are 1.5% and MDF amounts to 2.5%. In total, the brand owner spends 8% ($80,000) on incentives given to the distributor. This $80,000 is typically subtracted from revenue to calculate the net revenue of $920,000. The balance in the contra account is reduced when the corresponding asset or liability it is paired with is disposed of.

Partners carry other brands, including complimentary products and products that compete with the brand owner’s offerings. This allows partners to call on customers that the brand owner is not able to economically reach or serve. While this can help a brand owner increase sales, it also means the company needs to compete for the partner’s attention and time with respect to both the competitive and even the complimentary products. For example, when a partner takes time to identify an opportunity or design and/or specify the brand company’s product into an opportunity, that partner needs to be protected from the free-rider effect.