Normal Balance Meaning and Explanation

Normal Balance Meaning and Explanation

The financial and economic activities of any organization and accounting are closely intertwined. The history of accounting is almost six thousand years old and dates back to the 4th century BC. The emergence of accounting is associated with human economic activities.

Accounting is based on the implementation of control and accounting for the rational and economical use of all resources of the enterprise. All financial transactions, assets, economic activities, debts of the company are subject to accounting.

A qualified accountant must assess the company’s financial resources and liabilities, systematize all the transactions and provide the management with a reliable Balance sheet and other financial statements. This would not be possible without being familiar with accounting terms such as debits, credits, and normal balance.

Normal Balance Meaning and Explanation

Double-entry overview

First of all, we will give a definition. Double entry is a way most businesses are required to reflect transactions and facts of economic activity of an organization in accounting records. It allows them to systematize and group the facts of the economic activity of an entity according to individual characteristics and much more.

This method means a reflection of the facts of the economic activity of the enterprise on the accounts that are directly affected by this activity. An account is a record that summarizes all the transactions pertaining to a single item in the accounting equation.

One operation should be debited to one account and recorded as a credit on another simultaneously and for the same amount. This is the essence of the double-entry concept that the majority of businesses use to keep track of everything that is happening in the company in monetary terms.

Debits and credits

Now, we should recall the accounting equation, which is presented in the illustration below. With transactions, we say that an account goes up and an account goes down. For example, if you buy something with cash, what is going to happen is the Cash account will go down because you used cash to buy whatever it is.

The right accounting terms for this would be credit or debit. Those are the words that you will see used in the accounting world every time an entry has to be made in the company’s books. Debits and credits will affect different accounts differently. This is where normal balance comes in, so let’s take a closer look at this concept.

Normal Balance Meaning and Explanation

Normal balance

Account balance is the monetary amount in an account on a particular date. Normal balance is the side of the account, whether debit or credit, to which increases to the account are recorded.

So, which accounts increase with a debit? You should debit Expenses, Assets, and Dividends (acronym DEAD). This means that when these accounts go up (increasing), you debit them. So, if an expense goes up, you will debit it and if the asset goes up, you also debit it. As you might have guessed, to decrease these accounts, you will have to make a credit entry. Now, which accounts will a credit entry increase? We are sure you know the answer – all the other accounts or Liabilities, Revenue, and Equity.

To remember the rules of normal balance, associate it with the structure of the accounting equation. Debit and credit really just mean to the left or the right of the equal sign. Understanding this is important for the identification of bookkeeping errors.

If a closing balance is not what is expected (normal), this means that the manager should review what caused this. If an Accounts Payable account, for instance, shows a debit balance instead of credit, it might simply mean that you paid more than you owed or it can be a human or another error. It is also a key element of the double-entry system.

Examples

Whole Foods Inc., for instance, paid for advertising. This is an expense for this company. Was that expense going up? Yes, it just bought some advertising. The amount it paid will be entered on the debit side of an Advertising Expense. If it paid for advertising with cash, the cash is going down and Whole Foods Inc. would need to credit the Cash.

If Whole Foods Inc., on the other hand, used your credit card to pay for the advertising service, it will need to record this payment under liabilities because this company owes to the company doing the advertising for it. Its liability increased, so to reflect that in the accounting books, Whole Foods Inc. will credit the Advertising Accounts Payable.

Let’s consider another financial activity. You took a loan to support the growth of your company. The financial institution gave you cash, so your cash went up and you would debit this account. You also promised to pay back the loan this year, so you need to reflect this promise under liabilities, crediting the Loans Payable account.

Quentin Dcon

ByQuentin Dcon

Quentin Dcon specializes in accounting in this field requires a specialist's analytical skills, endurance and ability to work with a lot of information. He is here to share the latest news on accounting. Questions can be asked by email: [email protected] Contacts: +1 814-742-0523

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