Question

1. What is a contra account?
2. What is the difference between present value and future value of an investment? Illustrate your discussion with an example.

Answer 1

In simple terms, when an account is used to reduce the balance of another account, the account used to reduce the balance is a contra account.

Examples - Accumulated depreciation is a contra account for Machinery or equipment, sales returns is a contra account for sales account, allowance for doubtful debt is a contra account for account receivable account.

Present value is the value of the money as on today which is to be received in future.

Example - Present value of $100 to be received at the end of one year at 10% is $90.9 (ie. $100 should be multiplied with the present value factor (0.9091) of 10% at the end of one year.

Future value is the value of the money after a specific period of time at a specific rate in the future.

Example - Future value of $100 invested today at 10% for one year would be, $100 + ($100 X 10%) = $110.

Note: There are present value tables and future value tables to know the present value factors and future value factors. These factors are multiplied with the amount to know present values and future values.