A contra sets the amount a business owes to a supplier against the amount that same business owes it as a customer, so only the net balance is paid. In the books it is a journal: debit the purchase ledger control account and the supplier’s account, credit the sales ledger control account and the customer’s account, for the same amount. It needs the other party’s agreement, it does not change the VAT on either invoice, and unagreed balances must stay gross in the accounts.

When can amounts be set off by contra?

A contra is a settlement method, not a bookkeeping shortcut. HMRC’s guidance on part exchanges, barters and set offs describes it simply: if two businesses owe money to each other they may agree to set one amount against the other. If the amounts are the same, neither pays anything; if one owes more, only the balance is paid.

The key word is agree. Whether one side can insist on a set off without consent depends on the contract terms and the general law, so a unilateral contra invites a dispute. The usual practice is a short written agreement or a contra statement signed or confirmed by email by both sides, setting out the invoices on each side and the net amount.

Insolvency is the exception. Rule 14.25 of the Insolvency (England and Wales) Rules 2016 says that in a winding up, where there have been mutual dealings between the company and a creditor before liquidation, an account must be taken and the sums due from each must be set off. Only a balance owed to the creditor can be proved for; a balance owed to the company must be paid to the liquidator. Set off is then compulsory, whatever the parties prefer.

What are the double entries?

Suppose a business both sells to and buys from Smith Ltd. Smith appears in the sales ledger as a debtor and in the purchase ledger as a creditor. The contra is posted at the lower of the two balances, or at the agreed amount:

Ledger Debit Credit
General ledger Purchase ledger control account Sales ledger control account
Purchase ledger Smith Ltd supplier account
Sales ledger Smith Ltd customer account

Both control accounts and both individual accounts must be updated. ACCA’s examiner’s reports use a contra posted to the control account only as a standard cause of a difference between the control account and the list of customer balances. In ACCA’s FA1 pilot paper, a $2,000 contra entered in the control account but not in the receivables and payables ledgers has to be deducted from the receivables ledger total to correct it. See ledger control accounts for the reconciliation.

In most accounting software there is no single contra button. A common method is to post a journal to a contra clearing account, then allocate it against the customer invoices in the sales ledger and the supplier invoices in the purchase ledger, leaving the clearing account at nil. Never post a contra through the bank account as a payment and a receipt that did not happen.

What does a worked example look like?

Illustration only. A printer is owed £3,600 by Smith Ltd for printing (£3,000 plus £600 VAT). It owes Smith £1,440 for courier services (£1,200 plus £240 VAT). Both are VAT registered and agree a contra for £1,440.

Smith as customer Smith as supplier
Balance before contra £3,600 owed to printer £1,440 owed by printer
Contra (£1,440) (£1,440)
Balance after contra £2,160 owed to printer Nil

Smith pays £2,160 by bank transfer. The printer still accounts for the full £600 output VAT on its sale and reclaims the £240 input VAT on its purchase, subject to the normal rules; the contra moves gross balances, not VAT. The journal is £1,440, the VAT inclusive amount, because that is what each party owed.

How does VAT work on a contra?

HMRC’s guidance is clear that where both businesses are VAT registered, each must account for VAT on each separate supply made to the other, even if no money changes hands or only a net amount is paid after setting off one balance against the other. Netting the VAT, or invoicing only the difference, is wrong.

The same guidance sets the tax point. If an invoice is issued, the tax point is the invoice date. If supplies or mutual debts are set off simply by making an entry in the books to show that the amount is no longer outstanding, the tax point is when the entry is made, and VAT is due at that time on the full amount of the supply. HMRC also expects sales and purchase orders and shipping information to be kept for each supply, as well as the accounting entries.

Can balances be shown net in the accounts without a contra?

No. Until a set off is agreed or legally required, the debtor and the creditor are separate assets and liabilities. Paragraph 8 of Schedule 1 to SI 2008/410 says amounts representing assets may not be set off against amounts representing liabilities. FRS 102 paragraph 2.96 says assets and liabilities are not offset unless required or permitted by the standard, and paragraph 11.38A permits a financial asset and liability to be offset only where there is a currently legally enforceable right of set off and an intention to settle net or simultaneously.

In practice, a year end review that finds the same business on both ledgers should either complete a contra before the year end, with the agreement on file, or leave both balances gross.

What about group companies and connected businesses?

Contras are common between companies under common ownership, but each company is a separate legal person. A debt owed by one subsidiary should not be set against a debt owed to its sister company unless all the companies involved agree, usually in a written netting agreement, and each company records its own side. Our page on intercompany reconciliations explains how to keep the balances agreed. Where a netting leaves one group company owing another, record that as a new intercompany balance in both sets of books.

How do contras interact with bad debts?

If a customer who is also a supplier fails to pay, VAT bad debt relief is calculated on the net debt. VAT Notice 700/18, paragraph 3.7, gives the example of a debt of £720 (£600 plus £120 VAT) where the business owes the debtor £115 and can set it off: the debt is treated as £605, and relief is £605 multiplied by the VAT fraction of 1/6, or £100.83. Completing the contra first keeps the ledgers consistent with that calculation. See writing off a debt in the books for the entries that follow.

What mistakes come up most often?

  • Posting one side only, so one ledger no longer agrees with its control account.
  • Contra without agreement, leaving the supplier chasing an invoice it believes is unpaid.
  • Netting the VAT or raising a single net invoice instead of accounting for each supply in full.
  • Using the wrong entity, for example setting off against a sister company of the customer.
  • No audit trail. Keep the agreement and the invoice list with the journal, so the entry can be explained to an auditor or HMRC.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.