What is Normal Balance of Accounts?
Every account in a trial balance taken from bookkeeping ledgers shows either a debit balance or credit balance. The normal balance is an important part of the equation. Let’s take a look at normal balance accounting and answer the question of “What is the normal balance?”
What is a Normal Account Balance?
The normal balance of accounts is a series of information about the value of obligations and properties held by an organization. The normal balance is shown as a table on the sheets. Balance sheets are divided into “Assets” and “Liabilities,” and these two totals must be equal, hence the term “balance.”
The accounts’ normal balance is among the most important forms of accounting. Investors and business owners can use the normal balance to determine the financial situation of a company, including how much debt the business has and how many properties it owns.
Balance sheets include data up to a certain point, typically the end of a financial quarter or year. The Balance Sheet is different from the profit and loss statement, another important part of accounting, which includes financial results from a particular point in time, typically the start of the year.
Normal Balance and the Accounting Equation
In accounting, the total amount for liabilities must always be equal to the total amount for assets. This is because balance sheets are two different views of a singular business. These sheets show the credit and debit of a company.
This accounting equation is an integral part of the process. The assets of a company refer to resources the business owns and uses, while liabilities show the people behind the money and how much money they contributed. The resources a company owns are provided by either creditors or owners.
This gives us the equation that the sum of owners’ claims and the sum of creditors’ claims equal the sum of assets for an account. To keep it simple, the equation boils down to;
Assets = Liabiltiies + Equity.
The balance sheet offers a more detailed confirmation of the equation. The equation could also be presented as “Assets – Liabilities = Equity” to show that the claims from creditors are primary.
Every transaction, no matter the complexity or simplicity, can be represented by this simple equation. The balances of accounts are no different.
What are Contra Accounts?
When asking “What is normal balance,” it’s worth taking the time to also look at contra accounts.
These contra accounts are accounts that are offset against another account. For example, you may find a contra expense account, which covers things like purchase returns. There are also contra revenue accounts, which cover sales returns. A contra asset account covers things such as accumulated depreciation.
Given that these contra accounts are created to offset the balance for another account, the normal balance of accounts for a contra account should be the opposite of the original account.
Using the Normal Balance In Accounting
Normal balance accounting serves several purposes. The key purpose is that it offers a broad financial picture of the economic health of a business to interested parties, including – but not limited to;
- Organization owners
- State and federal agencies
- Banks that provide loans to the organization
- Potential sponsors
- Potential investors
- Contractors who deal with an organization
While each account has a normal balance, it’s possible for accounts to have either a credit or debit balance, depending on the bookkeeping entries in the account.
One of the benefits of having the normal balance is that if the account has a balance higher than the normal balance, for example, inventory accounts with a credit balance, then this is an indication there are errors on the account. These errors should be accounted for and amended as soon as possible.
Please note that if an account that is normally a debit balance will be increased by debit entries, while accounts that normally have a credit balance are increased by credit entry. Adding a debit entry for an asset account increases the asset balance while adding a credit entry to liability accounts increases the liability.
The Normal Balance of Accounts Chart
The accounting balance sheet should let you see not just the specific economic and financial situation from a set reporting date, but also analyze any changes and compare that information to data from previous years. Taking long-term development plans into account, a balance sheet makes it easier to forecast company activity and create a forecasted balance sheet.
Outside users typically have to submit the balance sheet on a year-by-year form according to a schedule, such as by month, quarter, or year. While you may be satisfied with the regular reporting form you use to submit reports to the state statistics bodies, please know there are other options to convert data into other accounting firms.
On the internal level, balance sheets let organizations analyze their current activities to better implement measures to correct and improve company performance. You can compile balance sheets at any point and in a variety of formats for this purpose.
The normal balance sheet is vital because it offers a comprehensive look at an organization’s financial activities. This includes information on how the company handles financial affairs and the effectiveness of those measures. The balance sheet lets you analyze current income and expenses and make an appropriate plan moving forward.
Normal Balance Examples
While examples of normal balance accounting can be found on most accounting/legal websites, here is a quick look at one example;
|Normal Balance of Accounts|
Identifying the type of account, such as an asset or liability, and putting it in the right column, helps determine if an account would typically have a credit or debit balance.
Here are some examples of balances of accounts and how they can be used, to help further understanding of the concept;
- Accounts payable normal balance – This is a liability and goes on the right side of the equation
- Accounts receivable normal balance – This is an asset and goes on the left side of the equation
- Cash normal balance – This is an asset and goes on the left side of the equation
- Cost of goods sold – This is an expense and goes on the left side of the equation
- Common stock normal balance – this is a capital credit balance and goes on the right side of the equation
Understanding normal balance accounting and how to use it gives you an introduction to the basics of double-entry bookkeeping. It’s not much of a challenge to understand which account type a transaction goes towards. This is the first step towards total understanding and it goes a long way towards proper normal balance accounting.
Keep in mind that practice makes perfect. The more you work with a normal balance and understand it, the better you’ll get at using it. It’ll become second nature to you in no time. Or you can hire a professional accountant who already has all the knowledge and experience of the normal balance of accounts to do the work for you.