Definition of 'Contra Account'
An account found in an account ledger that is used to reduce that value of a related account. Items recorded in the contra account are specifically designed to offset other transactions, and are recorded as the opposite type of entry. If a debit is recorded in a related account, the contra account record will be a credit.
Investopedia explains 'Contra Account'
Contra accounts are used for several reasons. They can be used to correct previous accounting mistakes, to reduce the value of an asset that is depreciating or to allot for uncollectible bills. Examples of contra accounts include Allowance for Uncollectibles, a contra account to Accounts Receivable and Accumulated Depreciation, a contra account to Assets.
Accountants use contra accounts rather than reduce the value of the non-contra account directly in order 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.
When accounting for assets, the difference between the asset’s account balance and the contra account balance is referred to as the book value. The allowance method of accounting allows a company to estimate what to place in the contra account, while the percent of sales method assumes that the company will not be able to collect payment for a fixed percentage of goods or services that it has sold. Both methods can help a company understand what write offs may do to its bottom line.