What Is a Contra Liability Account
In finance, a contra liability account is one that is debited for the explicit purpose of offsetting a credit to another liability account. Contra liabilities reduce liability accounts and carry a debit balance. In other words, the contra liability account is used to adjust the book value of an asset or liability.
- A contra account is an account used in a general ledger to reduce the value of a related account.
- A contra liability account adjusts the value of liabilities held by a company on its balance sheet.
- A contra liability may be generated due to the issuance of bonds or other debt securities.
Understanding Contra Liability Accounts
A contra account is used in a general ledger to reduce the value of a related account when the two are netted together. A contra account's natural balance is the opposite of the associated account. If a debit is a natural balance recorded in the related account, the contra account records a credit. For example, the contra account for a fixed asset is accumulated depreciation.
There are four key types of contra accounts—contra asset, contra liability, contra equity, and contra revenue. Contra asset accounts include allowance for doubtful accounts and the accumulated depreciation. Contra asset accounts are recorded with a credit balance that decreases the balance of an asset.
A liability that is recorded as a debit balance is used to decrease the balance of a liability. The balance of a contra liability account is a debit balance. This account decreases the value of the liability. Contra Liability a/c is not used as frequently as contra asset accounts. It is not classified as a liability since it does not represent a future obligation.
Examples of contra liabilities include a discount on notes or bonds payable. Contra liabilities hold a debit balance. Contra liability accounts are not as popular as contra asset accounts.
Companies that issue bonds are likely to use contra liability accounts. If the bond is sold at a discount, the company will record the cash received from the bond sale as "cash", and will offset the discount in the contra liability account.
Note that accountants use contra accounts rather than reduce the value of the original account directly to keep financial accounting records clean.
Example of a Contra Liability Account
For example, a $1,000 bond sold at $900 would result in the following journal entries:
- A $900 debit to the cash
- A $1,000 credit to the Bonds Payable
- A $100 debit to Discount on Bonds Payable.
Naming the journal entry for a contra liability account typically involves the use of the word “discount." For example, a contra liability account for the Notes Payable would be called the Discount on Notes Payable. The value of the notes is calculated as the credit balance in Notes Payable less the debit balance in Discount on Notes Payable.
In the above example, the debit to the contra liability account of $100 lets the company recognize that the bond was sold at a discount.