Contra Accounts Recording, Understanding, Types, Example

Discount on Bonds Payable is a contra liability account with a debit balance, which is contrary to the normal credit balance of its parent Bonds Payable liability account. The contra asset account carries a credit balance because an asset account usually has a debit balance. Such accounts are allowance for doubtful accounts and the accumulated depreciation account. The first time a contra asset account is recorded in a journal entry, it is to be deducted from the expense.

• Contra accounts appear on the same financial statement as the related account.
• This entry records $5,000 received for the accrued interest as a debit to Cash and a credit to Bond Interest Payable.
• In case a customer returns a product, the company will record the financial activity under the sales return account.
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• Discount On Bonds Payable is an account in the balance sheet recorded under the liabilities section.

This is done by separating the decreases that have occurred in the contra account from the original transaction amount. This allows the reader to see both the https://accounting-services.net/how-to-show-a-negative-balance/ current and historical book values for a particular asset or liability. When we issue a bond at a premium, we are selling the bond for more than it is worth.

What is a contra account?

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Amortization of the discount may be done using the straight‐line or the effective interest method. Currently, generally accepted accounting principles require use of the effective interest method of amortization unless the results under the two methods are not significantly different. If the amounts of interest expense are similar under the two methods, the straight‐line method may be used. A basic rule of thumb suggests that investors should look to buy premium bonds when rates are low and discount bonds when rates are high.

Amortization of Discount on Bonds Payable

Because premium bonds typically provide higher coupon payments, the biggest risk is that they could be called before the stated maturity date. For example, a contra account to Accounts Receivable is the Allowance for Doubtful Accounts or Bad Debt Reserve. Since it is a contra asset account, the Allowance for Doubtful Accounts must have a credit balance. The balance in this account represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible. Contra account is important as it not only allows a company to report the original amount of a transaction but also report any reductions that may have happened so that the net amount will also be reported. They are useful in preserving the historical value in the main account while presenting a write-down or decrease in a separate contra account that nets to the current book value.

Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon interest rate of 9% and semiannual interest payments payable on June 30 and Dec. 31, issued on July 1 when the market interest rate is 10%. The entry to record the issuance of the bonds increases (debits) cash for the $9,377 received, increases (debits) discount on bonds payable for $623, and increases (credits) bonds payable for the $10,000 maturity amount. Discount on bonds payable is a contra account to bonds payable that decreases the value of the bonds and is subtracted from the bonds payable in the long‐term liability section of the balance sheet. Initially it is the difference between the cash received and the maturity value of the bond. On July 1, Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon rate of interest of 12% and semiannual interest payments payable on June 30 and December 31, when the market interest rate is 10%.

What are the different types of contra accounts?

For example, a building is acquired for $20,000, that $20,000 is recorded on the general ledger while the depreciation of the building is recorded separately. This entry records $5,000 received for the accrued interest as a debit to Cash and a credit to Bond Interest Payable. It is important to understand the nature of the Discount on Bonds Payable account.

Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from large corporates and banks, as well as fast-growing start-ups. In this case, the carrying value of the bonds will begin at $97,000, since the $100,000 in Bonds Payable is offset by the $3,000 debit in Discount on Bonds Payable. Carbon Collective is the first online investment advisor 100% focused on solving climate change.

Adjunct Account

The debit balance in the Discount on Bonds Payable account will gradually decrease as it is amortized to Interest Expense over their life. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.

For instance, the allowance for doubtful accounts reduces the net amount of accounts receivable, while the reserve for obsolete inventory does the same for inventory. Similarly, accrued liabilities reduce the total amount of current liabilities. After the payment is recorded, the carrying value of the bonds payable on the balance sheet increases to $9,408 because the discount has decreased to $592 ($623–$31). If there was a discount on bonds payable, then the periodic entry is a debit to interest expense and a credit to discount on bonds payable; this has the effect of increasing the overall interest expense recorded by the issuer. The bonds are issued when the prevailing market interest rate for such investments is 14%. Sales returns, sales allowance and sale discounts are different examples of contra revenue accounts.

Contra accounts serve an invaluable function in financial reporting that enhances transparency in accounting books. The use of contra accounts ensures the accuracy of financial accounting records, as the value of the original accounts is not directly reduced. In the event that a contra account is not utilized, it can become increasingly troublesome to determine historical costs, which makes tax preparation time-consuming and difficult. 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.

An adjunct account is also sometimes just referred to as a valuation account. We strive to empower readers with the most factual and reliable climate finance information possible to help them make informed decisions. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

Amortizing Premiums and Discounts

Regardless of when the bonds are physically issued, interest starts to accrue from the most recent interest date. Firms report bonds to be selling at a stated price “plus accrued interest.” The issuer must pay holders of the bonds a full six months’ interest at each interest date. Thus, investors purchasing bonds after the bonds begin to accrue interest must pay the seller for the unearned interest accrued since the preceding interest date.

• Adjunct accounts are intended to provide additional detail to accounting figures and increase the overall transparency of financial reporting.
• The balance in this account represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.
• The $19 difference between the $469 interest expense and the $450 cash payment is the amount of the discount amortized.
• As the discount is amortized, the discount on bonds payable account’s balance decreases and the carrying value of the bond increases.
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