A contra account is an account that has a balance opposite to what the normal balance is for its category within the Chart of Accounts.
What does this mean?
Within the Chart of Accounts there are five categories: Assets, Liabilities, Equity/Capital, Revenue, and Expenses. Each of these categories have what is called a “normal balance” which specifies whether the accounts within the category have a debit or a credit balance. Keeping in mind that credit entries represent the sources of financing for our business and that debit entries represent the uses of that financing we can determine that the categories’ normal balances are as follows:
This means that a contra account in the Assets category would have a normal balance of a credit, a contra account in the Liabilities category would have a normal balance of a debit, and so on.
So, why do we use contra accounts?
Contra accounts are used to off-set another account within the same category and allow us to have a more accurate picture of the transaction taking place. For example, the “Sales” account within the Revenue category may have a contra account called “Sales Discounts”. This contra account would allow us to post the entirety of a sale (without the discount) into the “Sales” account while posting the discount amount into the “Sales Discounts” account. This not only provides a more accurate depiction of each sales transaction, but it also provides a more detailed report of sales come year-end.