Learning Outcomes
After reading this article, you will be able to explain what a contra entry is and recognize when it is used between payables and receivables control accounts. You will know how to record contra entries using double-entry bookkeeping, understand the effect on supplier and customer balances, and accurately identify relevant ledger postings. You will also be able to apply this knowledge to exam-style questions on the ACCA FA1 syllabus.
ACCA Recording Financial Transactions (FA1) Syllabus
For ACCA Recording Financial Transactions (FA1), you are required to understand how contra entries connect payables and receivables when two accounts exist between the same parties. This article focuses on:
- The purpose and mechanics of contra entries between payables and receivables
- The double-entry required for contra transactions
- Posting contra entries in control and individual ledger accounts
- Impact of contra entries on the trial balance and outstanding balances
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- When would a contra entry be made between payables and receivables control accounts?
- What is the double-entry for recording a contra between a trade payables balance and a trade receivables balance?
- In the case where Company A both sells to and buys from Company B, and both have outstanding balances, how are the balances affected after performing a contra?
- True or false? Contra entries only affect the individual ledger accounts, not the control accounts.
Introduction
In many businesses, it is common to trade with the same company as both a supplier (payable) and a customer (receivable). When both accounts have outstanding balances, instead of making separate payments, the balances can be offset using a contra entry. Understanding how contra entries are recorded and their effect on both control and individual ledger accounts is essential for recording accurate financial transactions and for your performance on the ACCA FA1 exam.
Key Term: Contra entry
A transaction that offsets an amount owed to a supplier with an amount due from the same party as a customer, clearing equal values from both payables and receivables accounts.Key Term: Control account
A general ledger account summarizing the total balances of multiple related individual accounts, such as all trade payables or all trade receivables.
Understanding Contra Entries
Contra entries arise when two businesses are both customers and suppliers to each other. Instead of paying and receiving cash separately, they agree to net the balances, clearing the smaller amount from both sides. This method saves time and reduces cash movement.
How Contras Work
Suppose your business owes a supplier $1,000, but that supplier also owes your business $600 as a customer. By performing a contra, you deduct the smaller amount from both balances:
- Amount you owe after contra: $1,000 - $600 = $400
- Amount they owe after contra: $600 - $600 = $0
Key Term: Netting off
Offsetting reciprocal balances between two accounts, so only the difference remains payable.
Double-entry for Contra
To record a contra in double-entry bookkeeping:
- Debit Trade payables (to reduce the liability)
- Credit Trade receivables (to reduce the asset)
This reduces both balances by the contra amount.
Key Term: Trade payables
Amounts owed by the business to suppliers for purchases made on credit.Key Term: Trade receivables
Amounts owed to the business by customers for sales made on credit.
Posting Contra Entries in the Ledgers
Contra entries affect both the control accounts and the individual supplier and customer accounts involved.
Worked Example 1.1
A business owes $1,500 to Powerline Ltd for goods purchased on credit. At the same time, Powerline Ltd owes the business $900 for goods bought on credit as a customer. Both parties agree to contra $900. What entries are required?
Answer:
- Debit Trade payables (Powerline Ltd) $900
- Credit Trade receivables (Powerline Ltd) $900 After the contra:
- New balance owed to Powerline Ltd: $1,500 - $900 = $600
- New balance owed by Powerline Ltd: $900 - $900 = $0
In Control Accounts
The payables and receivables control accounts both show a reduction equal to the contra amount. This ensures the total balances in the control accounts remain accurate and reconcile to the sum of the individual ledgers after the contra.
Worked Example 1.2
At month-end, your payables control account lists total suppliers’ balances at $12,000 and your receivables control account lists total customer balances at $15,000. During the month, you perform a contra of $2,000 between Company MX (who appears in both ledgers). What are the updated control account balances?
Answer:
- Payables control account is reduced by $2,000: $12,000 - $2,000 = $10,000
- Receivables control account is reduced by $2,000: $15,000 - $2,000 = $13,000
Exam Warning
Be sure you offset only the amount equal to the lower of the two balances between the same party. Do not try to contra more than is owed in either direction, and always record the correct double-entry.
Summary
Contra entries are an efficient way to net off mutual balances between payables and receivables control accounts for the same party. They reduce both liability and asset accounts equally, require both ledgers to be updated, and must be accurately reflected in the double-entry system.
Key Point Checklist
This article has covered the following key knowledge points:
- When and why contra entries are used between payables and receivables
- The double-entry required for contra transactions
- Impact of contra on both control accounts and individual accounts
- How to ensure the contra is for the correct (lowest) balance between the two ledgers
- The change in outstanding balances post-contra
- Potential exam pitfalls with recording or calculating contra entries
Key Terms and Concepts
- Contra entry
- Control account
- Netting off
- Trade payables
- Trade receivables