Normal Balance of Accounts

Overall, normal balance accounting definition the importance of normal balances in accounting cannot be overstated. By understanding and applying normal balances, accountants can ensure the integrity and usefulness of financial information. Accounts Payable is a liability account, and thus its normal balance is a credit.

GAAP, IFRS, and the Conceptual Framework

1. By adhering to the expected normal balances, accountants maintain the integrity and usefulness of the financial statements.
2. Recall that the accounting equation can be thought of from a “sources and claims” perspective; that is, the assets (items owned by the organization) were obtained by incurring liabilities or were provided by owners.
3. For example, a business might have certain expenses that are paid off (or reduced) over several time periods.
4. The going concern assumption assumes a business will continue to operate in the foreseeable future.

When we’re talking about Normal Balances for Revenue accounts, we assign a Normal Balance based on the effect on Equity. Because of the impact on Equity (it increases), we assign a Normal Credit Balance. Each account can be represented visually by splitting the account into left and right sides as shown. This graphic representation of a general ledger account is known as a T-account.

Revenue

This means that the new accounting year starts with no revenue amounts, no expense amounts, and no amount in the drawing account. Accounts Receivable is an asset account and is increased with a debit; Service Revenues is increased with a credit. Now that we have defined the concept of normal balance, let’s move on to examining some examples to further clarify its application.

Generally speaking, the balances in temporary accounts increase throughout the accounting year. At the end of the accounting year the balances will be transferred to the owner’s capital account or to a corporation’s retained earnings account. As we can see from this expanded accounting equation, Assets accounts increase on the debit side and decrease on the credit side. Liabilities increase on the credit side and decrease on the debit side.

Liabilities

For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account. This is an owner’s equity account and as such you would expect a credit balance. Other examples include (1) the allowance for doubtful accounts, (2) discount on bonds payable, (3) sales returns and allowances, and (4) sales discounts.

Each of the accounts in a trial balance extracted from the bookkeeping ledgers will either show a debit or a credit balance. The normal balance of any account is the balance (debit or credit) which you would expect the account have, and is governed by the accounting equation. Under the accrual basis of accounting the account Supplies Expense reports the amount of supplies that were used during the time interval indicated in the heading of the income statement.

Debits vs credits

Understanding the normal balance of different accounts is crucial for accurately recording transactions. Additionally, the normal balance affects financial ratios derived from the financial statements. Using normal balances ensures that these ratios are calculated correctly and reflect the intended analysis.

By following the expected normal balances, accountants can ensure that the financial statements accurately represent the financial position, performance, and cash flows of the business. Consistency in the presentation and classification of accounts enhances the comparability of financial statements across different periods and entities. Knowing the normal balances of accounts is pivotal for recording transactions correctly. It aids in maintaining accurate financial records and statements that mirror the true financial position of your business. Misunderstanding normal balances could lead to errors in your accounting records, which could misrepresent your business’s financial health and misinform decision-making. The debit or credit balance that would be expected in a specific account in the general ledger.

By recording transactions with the appropriate normal balances, the equation stays in equilibrium, and the financial statements accurately represent the financial position and performance of the business. The account’s net balance is the difference between the total of the debits and the total of the credits. This can be a net debit balance when the total debits are greater, or a net credit balance when the total credits are greater. By convention, one of these is the normal balance type for each account according to its category. In the case of a contra account, however, the normal balance convention is reversed and a normal balance is reported either as a negative number, or alongside its parent balance as an amount subtracted. By understanding the normal balance concept, you can correctly record transactions, such as the cash injection and the equipment purchase, in your double-entry bookkeeping system.