A contra liability account is a type of contra account that is reported with a company's liabilities but carries a debit balance, reducing the related liability to its carrying amount. Liabilities normally have credit balances, so a debit balance in this position is the sign of a contra account.
Discount on bonds payable as a contra liability
The classic example is discount on bonds payable. When market interest rates are higher than a bond's stated rate, investors pay less than face value. Suppose a company issues bonds with a face value of $1,000,000 and receives $960,000. It records a debit to Cash of $960,000, a debit to Discount on Bonds Payable of $40,000 and a credit to bonds payable of $1,000,000. The balance sheet shows bonds payable of $1,000,000 less the $40,000 discount, a carrying amount of $960,000.
The discount is extra borrowing cost, because the company will repay $1,000,000 after borrowing only $960,000. Over the life of the bonds it is amortized, usually by the effective interest method, with each period's amortization added to interest expense. The contra balance shrinks each year, so the carrying amount rises until it equals face value on the maturity date. A similar account, Discount on Notes Payable, is used for notes issued at less than face value. Under US GAAP, debt issuance costs are also presented as a direct deduction from the carrying amount of the debt rather than as a separate asset, which works in the same way as a discount.