What is a Contra Inventory Account?

A contra inventory account is a general ledger account that is paired with the inventory account, and which contains a negative balance that represents a reserve for obsolete or damaged goods. When offset against the related inventory account, the contra account results in a lower reported level of inventory in the financial statements.

Example of a Contra Inventory Account

A manufacturer has an inventory account in which the current balance is $100,000. It has an offsetting contra inventory account, which is entitled the allowance for obsolete inventory, which contains a negative balance of $5,000. The net inventory balance reported by the company on its balance sheet is $95,000, which is the net amount of these two values. This accounting treatment ensures that its reported inventory is not overstated and aligns with the principle of conservatism in accounting.

When to Use a Contra Inventory Account

There are several situations in which a contra inventory account can be used. One is when market prices are lower than inventory costs, which will trigger a lower of cost or market adjustment. It is also useful when inventory is quite old or turnover levels are low. A third possible use for the account is when some of the inventory is no longer listed in the bills of material for current products, and so will not be used.

When Not to Use a Contra Inventory Account

There are several situations in which a contra inventory account is not likely to be needed. One case is when inventory turnover levels are extremely high for all items, so that inventory rarely stays on the shelf for long. Another case is when inventory is so subject to spoilage that older items will probably be thrown out before they could impact the contra account. A good example is a restaurant, where the staff will likely inspect the inventory every few days and throw out spoiled items.