A contra account contains a normal balance that is the reverse of the normal balance for that class of account. The contra accounts noted in the preceding table are usually set up as reserve accounts against declines in the usual balance in the accounts with which they are paired. For example, a contra asset account such as the allowance for doubtful accounts contains a credit balance that is intended as a reserve against accounts receivable that will not be paid. The exceptions to this rule are the accounts Sales Returns, Sales Allowances, and Sales Discounts—these accounts have debit balances because they are reductions to sales. Accounts with balances that are the opposite of the normal balance are called contra accounts; hence contra revenue accounts will have debit balances.
In contrast, a credit, not a debit, is what increases a revenue account, hence for this type of account, the normal balance is a credit balance. In accounting terminology, a normal balance refers to the kind of balance that is considered normal or expected for each type of account. For asset and expense accounts, the normal balance is a debit balance.
A practical example of normal balance
An asset is anything a company owns that holds monetary value. This means that when you increase an asset account, you make a debit entry. For instance, when a business buys a piece of equipment, it would debit the Equipment account. Whenever cash is received, the asset account Cash is debited and another account will need to be credited.
Misunderstanding normal balances could lead to errors in your accounting records, which could misrepresent your business’s financial health and misinform decision-making. It’s essentially what’s left over when you subtract liabilities from assets. When owners invest more into the business, you credit the equity account, hence, it has a normal credit balance.
Why are expenses debited?
This means when a company makes a sale on credit, it records a debit entry in the Accounts Receivable account, increasing its balance. Conversely, when the company receives a payment from a customer for a previously made credit sale, it records a credit entry in the Accounts Receivable account, decreasing its balance. All this is basic and common sense for accountants, bookkeepers and other people experienced in studying balance sheets, but it can make a layman scratch his head. To better understand normal balances, one should first be familiar with accounting terms such as debits, credits, and the different types of accounts. Basically, once the basic accounting terminology is learned and understood, the normal balance for each specific industry will become second nature.
- A credit to a liability account increases its credit balance.
- Thus, if the entry under the balance column is 1,200, this reflects a debit balance.
- Since the service was performed at the same time as the cash was received, the revenue account Service Revenues is credited, thus increasing its account balance.
- The same is true for all expense accounts, such as the utilities expense account.
- In accounting, understanding the normal balance of accounts is crucial to accurately record financial transactions and maintain a balanced ledger.
In accounting, understanding normal balance will help you keep a close watch on your accounts and to know if there is a potential problem. This article gives great information that helps the reader understand this important accounting concept. Asset, liability, and most owner/stockholder equity accounts are referred to as permanent accounts (or real accounts). Permanent accounts are not closed at the end of the accounting year; their balances are automatically carried forward to the next accounting year. In accounting, ‘Normal Balance’ doesn’t refer to a state of equilibrium or a mid-point between extremes. Instead, it signifies whether an increase in a particular account is recorded as a debit or a credit.
As mentioned, normal balances can either be credit or debit balances, depending on the account type. Whether the normal balance is a credit or a debit balance is determined by what increases that particular account’s balance has. As such, in a cash account, any debit will increase the cash account balance, hence its normal balance is a debit one. The same is true for all expense accounts, such as the utilities expense account.
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A credit to a liability account increases its credit balance. An abnormal balance can indicate an accounting or payment error; cash on hand should never have a net credit balance, since one cannot credit (pay from) cash what has not been debited (paid in). Similarly, there is little reason for a business to pay a liability in excess of what it owes. On the other hand, a business that has not reached profitability will debit a cumulative earnings/loss equity account with its losses, resulting in a negative balance.
Temporary accounts (or nominal accounts) include all of the revenue accounts, expense accounts, the owner’s drawing account, and the income summary account. 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 noted earlier, expenses are almost always debited, so we debit Wages Expense, increasing its account balance. Since your company did not yet pay its employees, the Cash account is not credited, instead, the credit is recorded in the liability account Wages Payable.
The normal balance can either be a debit or a credit, depending on the type of account in question. It is the side of the account – debit or credit – where an increase in the account is recorded. A normal balance is the expectation that a particular type of account will have either a debit or a credit balance based on its classification within the chart of accounts. It is possible for an account expected to have a normal balance as a debit to actually have a credit balance, and vice versa, but these situations should be in the minority. The normal balance for each account type is noted in the following table.
Why Expenses Are Debited
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Example of Why Expenses Are Debited
Accounts Payable is a liability account, and thus its normal balance is a credit. When a company purchases goods or services on credit, it records a credit entry in the Accounts Payable account, increasing its balance. Conversely, when the company makes a payment on its account payable, it records a debit entry in the Accounts Payable account, decreasing its balance. By understanding and tracking the normal balance of Accounts Payable, businesses can manage their short-term financial obligations efficiently. Expenses normally have debit balances that are increased with a debit entry. Since expenses are usually increasing, think “debit” when expenses are incurred.
Normal account balance definition
In accounting, debits and credits are the fundamental building blocks in a double-entry accounting system. Depending on the account type, an increase or decrease can either be a debit or a credit. Understanding the difference between credit and debit is needed. Expenses are the costs a company incurs to generate revenue. If a company pays rent, it would debit the Rent Expense account.