When it comes to setting up your business' accounting, there's a wide variety of different accounts you can use to keep your finances organized and running smoothly. While these accounts normally fall under the broad categories of income accounts and expense accounts, some are tailored to very specific purposes, and the valuation account is one such account.
So what is a valuation account and what is it used for? It's usually a balance sheet account, and its purpose is to combine with another balance sheet account so that you can report the carrying amount of an asset or a liability. Of course, this brings up the questions: what is a balance sheet account? And what is a carrying amount?
What is a Balance Sheet Account?
The balance sheet is one of the primary financial statements in accounting. Balance sheet accounts are those that deal with transactions related to assets, liabilities, and owner's equity, aka the three variables that make up the accounting equation. Accounts like Cash, Retained Earnings, Accounts Receivable and Accounts Payable are all found on the balance sheet.
At the end of each accounting year, the balance of these accounts is carried forward into the next year, rather than being closed (income statement accounts, on the other hand, are closed out at year-end and start each new accounting year with a zero balance).
What is a Carrying Amount?
The amount associated with an asset or liability that is recorded on a company's books is known as the carrying amount (sometimes also known as the "book value"). BAssets are resources like equipment and cash owned and controlled by your company that can lead to financial gain. Liabilities are debts your company owes that must be paid off in the future (such as bank loans or credit card debt).
The carrying amount is different than the market value, as factors like depreciation come into play. For example, the carrying amount of a piece of equipment owned by your company is the cost of the equipment minus its accumulated depreciation.
Examples of Valuation Accounts
Now that we know the basics of the valuation account and its purpose, let's take a look at a couple of examples. The credit balance of the Allowance for Doubtful Accounts is combined with the debit balance of Accounts Receivable to get the carrying amount of your company's receivables. The Allowance for Doubtful Accounts is an example of a valuation account related to an asset (the company's receivables).
Unsure of the difference between a credit balance and debut balance? Brush up on debits and credits in accounting.
An example of a valuation account based on a liability is the Discount on Bonds Payable, whose debit balance is combined with Bonds Payables' credit balance to get the carrying amount of the company's bonds.
Organizing your business' finances into the correct set of accounts will help you gain a better understanding of your company's financial health, and provide you with another tool to make smart business decisions.