Now that we have explored the relationship between normal balances and assets, liabilities, and equity, let’s move on to discussing the importance of normal balances in accounting. Next, let’s explore the relationship between normal balances and the categories of assets, liabilities, and equity in accounting. This becomes easier to understand as you become familiar with the normal balance of an account.
As we can see from this expanded accounting equation, Assets accounts increase on the debit side and decrease on the credit side. This becomes easier to understand as you become familiar with the normal balance of an account. Normalizing entries are typically made at the end of an accounting period to ensure that the financial statements accurately represent the business’s ongoing operations. These adjustments help remove distortions caused by extraordinary or non-recurring events, allowing for a more meaningful analysis of the business’s financial performance and trends.
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. 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. It’s essentially what’s left over when you subtract liabilities from assets.
Understand the concept of normal balance in accounting and its significance in finance. Let’s say there were a credit of $4,000 and a debit of $6,000 in the Accounts Payable account. Since Accounts Payable increases on the credit side, one would expect a normal balance on the credit side. However, the difference between the two figures in this normal balance of accounts case would be a debit balance of $2,000, which is an abnormal balance. This situation could possibly occur with an overpayment to a supplier or an error in recording. From the table above it can be seen that assets, expenses, and dividends normally have a debit balance, whereas liabilities, capital, and revenue normally have a credit balance.