In general, a contra account offsets another, related account, with the result being a reduced net balance for the two paired accounts. A contra liability account reduces the balance in a paired liability account.
Thus, a normal liability account has a credit balance, so a contra account associated with it has a normal debit balance. A contra account may also have a zero balance, if no offset against a related liability account is currently needed.
The following are examples of contra liability accounts:
- Bond discount account. This account offsets the bond payable account. When netted together, the two accounts yield the carrying value of a bond.
- Gain on debt reduction. This account offsets the remaining balance in a loan payable account in the amount of any negotiated reduction in debt, which may occur when a borrower is having trouble meeting its loan payment obligations. This presentation is rarely used, in favor of directly reducing the balance in the loan payable account and reporting the reduction as a gain on the income statement.
If the amount in a contra liability account is immaterial, it could reasonably be combined into a single balance sheet line item with the liability that it is intended to offset.
In practice, contra liability accounts are rarely used. Contra accounts are more commonly paired with asset accounts, such as accounts receivable or inventory, to reduce the carrying values of those assets.
A contra account is also known as a valuation allowance, because it adjusts the carrying value of the account with which it is paired.