A contra inventory account is a general ledger account with a credit balance. The credit balance of the contra inventory account is combined with the debit balance in the inventory account when a balance sheet is prepared.

If a company reports its inventory at the lower of cost or market, it often records the costs of the items in its Inventory account and uses the contra inventory account Allowance to Reduce Inventory to the Lower of Cost or Market to report a lower amount of inventory on its balance sheet. For example, if the Inventory account has a debit balance of $40,000 for the cost of the goods on hand at a balance sheet date, but the market (replacement cost constrained by a floor and a ceiling) is $37,000, the Allowance account will be adjusted to show a credit balance of $3,000.

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