The term account is used broadly in business in at least two related but different ways:First, an account represents a formal agreement between two parties, usually a seller and a customer, with certain rights, privileges, and obligations for each party.Second, an account is one of the elementary building blocks of an accounting system--a placefor recording changes in value (additions and subtractions) related to a single specific asset, liability, owners equity, revenue or expense. Thediscussion below is concerned primarily with defining, explaining, and illustrating account as an accounting concept (the meaning above),along withrelated terms such as double entry bookkeeping, contra account, valuation allowance account, and chart of accounts.Contents The account as a seller-customer relationship Account explained as the fundamental building block of an accounting system The meaning of contra accounts (valuation allowance accounts) The meaning of chart of accounts: Chart of accounts exampleThe account as a sellercustomer relationshipIn many kinds of situations, customersestablisha special kind of relationship with sellers by creating an account with the seller. The relationship between seller and customer is then different from the customer/seller relationshipinvolved in a one-time purchase transaction.Theaccount implies the relationship will continue for a period of time, during which seller and customerhave rights, privileges, and obligations towards each other, which do not apply to those who are without theaccount relationship.A customer with a bank account, for instance,may havethe right to deposit and withdraw funds, write checks against the account, and receiveinterest payments for the bank's use of depositor funds. The bank (the seller) on the other hand, may have the right to use the depositor's funds for its own investments and charge the account holder maintenance fees. Many sellers recognize the special relationship they have with their customers by calling each customer an "account," for which they plan and dedicate sales and service resources.Account explained as the fundamental building block of an accounting systemIn business, each profit making company establishes an accounting system in order tomanage and keep track of incomingand outgoing funds. The accounting system also provides the basisthe basis for financial reports the companymust file periodically. The basic building block in such a system is the account,which can be defined as a place for recordingchanges invalue (additions and subtractions) for one specific purpose. In fact, "specific purposes" are divided into five categories, and these categories represent the fivethe only fivekinds of accounts possible in an accounting system based on double-entry principles:First, there are the so-called "balance sheet" kinds of accounts:1. Asset accounts: Things of value that are owned and used by the business. Example: Cash onhand Example: Accounts receivable2. Liability accounts: Debts that are owed by the business. Example: Accounts payable Example:Salaries payable3. Equity accounts: The owner's claim to business assets. Example:Owner capital Example: Retained earningsSecondly, there are the so-called "income statement" kinds of accounts"4. Revenue accounts: The amounts earned from the sale of goods and services. Example:Product sales revenues Example: Interest earned revenues5. Expense accounts: Costs incurred in the course of business. Example: Direct labor costs Example: Advertising expensesIn reality, even a very small business may identify a hundred or more such accounts for its accounting system, and a very large company may identify many thousands. Nevertheless, for bookkeeping and accounting purposes, all named accounts fall into one of the five categories above (see Chart of accounts, below). Every financial transaction for the company is recorded as a change in an account. If the company uses double-entry book keeping (as nearly all companies do), every financial transaction causes two equal and offsetting account changes, the change in one account called a debit and the change in another accountcalled a credit. In the double entry system, just how the bookkeeper and account handle each transaction for an accountdepends on which of the five account categoriesthe account belongs to. Whether a debit or a credit increases or decreases the account balance depends on the kind of account involved:Debit (DR) Entry ... Credit (CR) Entry ...

Asset accountIncreases (adds to) account balanceDecreases (subtracts from) account balance

Liability accountDecreases (subtracts from) account balanceIncreases (adds to) account balance

Equity accountDecreases (subtracts from) account balanceIncreases (adds to) account balance

Revenue accountDecreases (subtracts from) account balanceIncreases (adds to) account balance

Expense account Increases (adds to) account balanceDecreases (subtracts from) account balance

Suppose, for example, that a company acquires assets valued at $100,000. An asset account will increase (be debited) $100,000 (perhapsasset Account163 from the chart of accounts below, Factory manufacturing equipment). The increase in account balance is called a debit because this is an asset account. However, the balance sheet is now temporarily out of balance until there is an offsetting credit of $100,000 to another account, somewhere in the accounting system. This could be, for instance: A credit of$100,000 to another asset account, reducing that account value by $100,000 (from the chart of accounts below, that could be a credit to asset Account 101, Cash on hand). If the asset purchase is financed with a bank loan instead of the company's cash, however, the offsetting transaction could be a credit to a liability account, increasing that account value by $100,000 (which could be Account 171, Bank loans payable).In this way, the basic accounting equation always holds and the balance sheet stays balanced: Assets = Liabilities + EquitiesAnd, for every pair of account entries that follow from a single transaction:Debits = CreditsSee the encyclopedia Double entry system for more on the accounting mathematics involved in double entry bookkeeping. The meaning of Contra account (Valuation allowance account)Not all accounts work additively with each other on the primary financial accounting reportsespecially on the income statement and balance sheet. There are many instances where one account works to offset the impactof another account. The so-called contra accounts "work against" other accounts in this way. In some situations, the contra accounts reverse the debit and credit rulesfrom the table above. Contra-asset and contra-liability accounts are also called valuation allowance accounts, because they work to adjust the book value, or carrying value for assets or liabilities, as shown in the examples below.The balance sheet example runningthroughout this encyclopedia has severalcontra account examples,including these under Assets:

You may notice from the chart of accounts example below, that Accounts receivable (Account 110 from the chart) and Allowance for doubtful accounts (Account 120) are both asset accounts.Allowance for doubtful accounts, however, is a contra asset account that reduces the impact (carrying value) contributed by Accounts receivable. The balance sheet result is a "Net accounts receivable" less than the Accounts receivable value.In the same way,Account 163, Factory Manufacturing equipment carries the value of these assets at historical costwhat was actually paid for these assets. This will notdecrease as long as the company owns the assets.However, the asset's book value does change downward from year to year, as shown on thebalance sheet.Contra Account 175, Accumulated depreciation, factory manufacturing equipment, is subtractedfrom the Account 163 value, to produce the balance sheet result Net factory manufacturing equipment. In each case above, incidentally there is also an expense categoryaccount involved, and those appear on the income statement, not the balance sheet.In the first example, the expense account isBad debt expense and in the second case, the expense account is Depreciation expense, factory machinery. The offsetting debit and credit transactionsmight look like this way in the bookkeeper's journal (the chronological record of transactions):Grande CorporationJournal for Fiscal Year 20YY

DateAccountDebitCredit

30-Jun-20YY30-Jun-20YY31-Jul-20YY31-Jul-20YY 630Bad debt expense120 Allowance for doubful accounts770Depreciation expense, factory manufacturing equip175 Accumuulated depreciation expense, factory manufacturing equipment $137,000

$2,782,000 $137,000

$2,782,000

All four transactions add to the value of the accounts listed. Debiting each of the two expense accounts adds to account value, as you would expect from the table in the previous section. However notice here that crediting the two asset accounts adds to their value as welljust the opposite of what the same table prescribes for asset accounts. For contra accounts in this situation the rules are reversed, so that the fundamental equation Debits = Credits still holds for every pair of transactions. The examples also show why a contra asset account is said to hold a credit balance.The above examples show contra-asset accounts, but there are also examples of contra-liability accounts that operate in the same way. For example, on the liabilities side of the balance sheet,along term liability account Bonds payable may be accompanied by another liability account, a contra liability account called Discounts on bonds payable.The value in thecontra account reduces the company's actual liability from the stated figure in the Bonds payable account. Contra liability accountslike their contra asset account counterpartsalso reverse the debit/credit "rules" from the table in the previous section. An addition to a liability account is normally a credit, but to a contra liability account, an addition is a debit. For this reason, contra liability accounts are said to carry a debit balance.The meaning of Chart of accounts and Chart of accounts exampleOne of the first steps in setting up a new accounting system is the creation of achart of accounts, which is simply a listthe complete listof named accounts that the company expects to use for recording and reporting financial transactions. The same list of accountswillbe in view throughout the company's entire accounting/bookkeeping cycle. When transactions occur:1. Transactions, as debits or creditsto accounts, areentered first in a journal. Journals record transactions chronologically, that is, inthe order they occur. This and the next step are normally the responsibility of bookkeepers.2. The next step occurs when thejournal transactions are transferred (posted) to a ledger. ( A ledger is a collection of accounts, organized by account type and purpose). 3. Finally, the ledger transactions contribute to the financial accounting statements, starting with the income statementandbalance sheet, but also including Statement of changes in financial position and statement of retained earnings. The preparation of these reports from ledger entries is normally the responsibility of an accountant.When setting up an accounting system using an accounting software application, the software will at the outset suggest account names for the chart of accounts, based on the size of the company and the nature of its business. Some small companies will simply use the program's default suggestions, but others will tailor the list to better fit their own situation. In any case the accountant, consultant, or business owner setting up the chart of accounts should be guided by these objectives for the chart: Accounts must beincluded to represent all of the five basic account categories (assets, liabilities, equities, revenues, and expenses). Thechart should include enoughnamed accounts toprovide the resolution management will need to control and manage operations effectively (i.e., there should be enough accountsto show separately each area or entity of interest). On the other hand, the materiality concept suggests thataccounts for trivial,small, or rarely used items canbe omitted. When these transactions do occur, they will be enteredunder the headings ofa few more general and inclusive accounts. Each account should have a unique number as well as a name. Account numbers should be chosen to show which category an account belongs to, and which accounts within category are similar to each other (see the example chart of accounts extract below). The initial set of account numbers should allow for later expansion of the list. E.g. the chart might initially list Account 140, Prepaid Expenses, followed byAccount150, Employee Advances. If the need arises later to add another account between these two, there are nine account numbers available.Example chart of accountsThe example chart of accounts below is really better described as an extract from a chart of accounts, rather than a complete chart. Itshows the structure and general approach to account numbering and naming, but a complete exampleeven for a very small companywould no doubt list many more accounts.Acct NoCHART OF ACCOUNTS

Asset Accounts - Current Assets

&100Petty cash

101Cash on hand

103Regular checking account

105Payroll checking account

110 Accounts receivable

120Allowance for doubtful accounts

130 Work in progress inventory

139 Finished goods inventory

140 Prepaid expenses

150 Employee advances

Asset Accounts - Fixed Assets

160 Furniture and fixtures

162 Vehicles

163 Factory manufacturing equipment

165 Buildings

169Land

170Accumulated depreciation, furniture,fixtures

172Accumulated depreciation, vehicles

175Accumulated depreciation, factory mfr equip.

179Accumulated depreciation, buildings

Asset Accounts - Other Assets

190Accumulated amortization

194Notes receivable, non current

Liability Accounts - Current Liabilities

200Accounts payable

234 Payroll payable

235Accrued fees

240Accrued interest

Liability Accounts - Long Term Liabilities

260Bonds payable

270Discount on bonds payable

280Bank loans payable

290Equipment payable

Equity Accounts

320Owner capital

350Retained earnings

380Dividends

Revenue Accounts

410Product sales revenues

420Services sales

430Rental property revenues

450Interest earned revenues

Expense Accounts - Cost of Goods Sold

520Raw materials costs

530Direct labor costs

540Indirect labor costs

550Manufacturing plant costs

Expense Accounts - Other

601Supplies expense

630Bad debt expense

650Advertising expense

720Salary and wage expense

735Travel expenses

750 Equipment lease expense

760Depreciation expense, vehicles

770 Depreciation expense, factory mfr equipment

800Other expenses