Accounts, and the five types

Every account belongs to exactly one of five types, and its type decides which side increases it. Get the type right and the entry writes itself.

Reading: 9 min
Teaches: 9
Sources: 4

An account is a bucket with a name and a number, and the chart of accounts is the list of them. It is the one piece of setup that is genuinely hard to change later, because every entry ever posted points at it — so the goal is the smallest chart that answers the questions you actually ask.

Northwind runs eighteen accounts. That is enough for a real month with real judgment in it, and small enough to hold in your head.

Northwind Traders chart of accounts
Code	Name	Type	What belongs in it
1000	Cash — operating	Asset	The operating bank account. Only what the bank would agree to.
1200	Accounts receivable	Asset	Invoices issued and not yet collected.
1300	Inventory	Asset	Goods bought to sell, at what they cost us.
1400	Prepaid insurance	Asset	Insurance paid for but not yet consumed.
1500	Vehicles	Asset	The van, at cost. Never at what it is worth today.
1590	Accumulated depreciation — vehiclescontra	Asset	Every dollar of the van's cost already charged to a period.
2000	Accounts payable	Liability	Vendor bills received and not yet paid.
2200	Accrued liabilities	Liability	Costs incurred where no bill has arrived yet.
2400	Deferred revenue	Liability	Cash taken for goods not yet delivered.
3000	Common stock	Equity	What the founders paid in for their shares.
3100	Retained earnings	Equity	Cumulative net income, less dividends. Zero at the start of a first period.
4000	Revenue	Revenue	Goods delivered to a customer, at the price agreed.
5000	Cost of revenue	Expense	What those delivered goods cost us.
6000	Payroll expense	Expense	Wages for the period.
6200	Rent expense	Expense	The premises, for the period.
6300	Insurance expense	Expense	The month's share of the insurance policy.
6400	Depreciation expense	Expense	The month's share of the van.
6500	Utilities expense	Expense	Power and water for the period, billed or not.

Northwind's chart of accounts. The numbering is convention, not GAAP: 1000s assets, 2000s liabilities, 3000s equity, 4000s revenue, 5000s and 6000s expenses.

Fig 3.1Chart of accounts

Drag to turn · click for the next account18 accounts

Northwind's chart, in number order: 1000s assets, 2000s liabilities, 3000s equity, 4000s revenue, 5000 and up expenses. The number says what kind of account it is before the name does.

Normal balances

Each type has a side that increases it — its normal balance. This is not a convention you memorise and then apply; it falls straight out of the equation. Assets sit on the left of A = L + E, so assets increase on the left. Liabilities and equity sit on the right, so they increase on the right. Revenue increases equity, so it behaves like equity. Expenses decrease it, so they behave the opposite way.

Type	Increases on	Decreases on	Northwind example
Asset	Debit	Credit	1000 Cash — operating
Liability	Credit	Debit	2000 Accounts payable
Equity	Credit	Debit	3000 Common stock
Revenue	Credit	Debit	4000 Revenue
Expense	Debit	Credit	6000 Payroll expense

Learn this table and you never have to memorise another rule about debits.

Contra accounts

One account in Northwind's chart breaks the pattern on purpose. 1590 Accumulated depreciation is an asset account that carries a credit balance, because it exists to be subtracted from the van. That is a contra account: it is presented as a deduction from its parent, so the balance sheet can say both the van cost $24,000 and $500 of it has been used up, instead of quietly showing $23,500 and losing the cost forever.

Wrong

1500 Vehicles    23,500

Right

1500 Vehicles    24,000
1590 Accumulated depreciation   (500)

Netting a contra account into its parent destroys information a reader needs — how old the asset is, and how much life is left in it.

Your turn

Sort eight accounts into five types

Set the type on every row. Two are traps: deferred revenue has the word revenue in it and is a liability, and accumulated depreciation carries a credit balance and is still an asset — a contra asset.

Sort eight accounts into five types
Row	AAccount	BName	CType
1
2
3
4
5
6
7
8
9
10
11

Pick a type on the first row to begin.

Check yourself

2400 Deferred revenue holds a customer's deposit for goods not yet delivered. What type of account is it?

Where this lesson's rules come from

Requirements, conventions and mechanics are three different things. These are the sources behind the requirements — and the ones marked as conventions are ours, not the standard-setters'.

CON 8, Ch. 4, ¶E16Definition of an assetFree to read
CON 8, Ch. 4, ¶E80–E81Definitions of revenues and expensesFree to read
Regulation S-X, 17 CFR 210.5-02The balance sheet captions a registrant must presentFree to read
ASC 505EquityFree after registration

The full map is in US GAAP, and where these rules come from.

The words this lesson teaches

Each links to its definition in the glossary, where it also states the authority behind it and the components that render it.

In the founder glossary

The ideas in this lesson, explained for the founder who runs the company. Each has its own entry in the founder glossary.