Contra Expense
A contra expense account is a type of account in financial accounting that offsets the balance of a corresponding expense account. Contra expense accounts have a credit balance, which is the opposite of the typical debit balance found in expense accounts. The purpose of a contra expense account is to reduce the total expenses shown on the income statement by reflecting specific adjustments, recoveries, or reimbursements related to the expense.
One common example of a contra expense account is Purchase Discounts:
- Purchase Discounts: This contra expense account represents the discounts received from suppliers on purchases made by a company. When a company receives a discount for prompt payment or other reasons, it records the amount of the discount in the purchase discounts account, which reduces the total purchases expense reported on the income statement. Since purchase discounts is a contra expense account, it has a credit balance, which is the opposite of the typical debit balance found in other expense accounts, such as cost of goods sold or operating expenses.
By using contra expense accounts, financial statement users can gain a more accurate and detailed understanding of the company’s expense structure, allowing for better financial analysis and decision-making.
Example of a Contra Expense
Let’s consider a fictional example of a small retail business called “GadgetHub” to illustrate the use of a contra expense account in financial accounting.
GadgetHub purchases inventory from suppliers and records the cost of goods sold (COGS) as an expense. During a particular month, GadgetHub has the following transactions:
- Purchased inventory worth $100,000.
- Received a 2% discount on the total inventory purchase for making a prompt payment.
To record these transactions, GadgetHub will create a contra expense account called “Purchase Discounts.
The cost of goods sold (COGS) account will have a debit balance of $100,000, representing the initial cost of the inventory. The purchase discounts account will have a credit balance of $2,000 (2% of $100,000), which represents the discount received from the supplier.
On the income statement, the net cost of goods sold will be reported as $98,000 ($100,000 – $2,000), reflecting the impact of the purchase discount.
In this example, the contra expense account (Purchase Discounts) is used to provide a more accurate and detailed representation of the company’s expenses, allowing for better financial analysis and decision-making. By accounting for discounts and other adjustments, GadgetHub can track its actual expenses more effectively and make more informed decisions about its inventory purchases and supplier relationships.
