Under the accrual basis of accounting, the Service Revenues account reports the fees earned by a company during the time period indicated in the heading of the income statement. Service Revenues include work completed whether or not it was billed. Service Revenues is an operating revenue account and will appear at the beginning of the company’s income statement.

Role of Normal Balances in Maintaining Accurate Financial Records

Each month, you prepare a trial balance showing your company’s position. After preparing your trial balance this month, you discover that it does not balance. The debit column shows $2,000 more dollars than the credit column. One of the most well-known financial schemes is that involving the companies Enron Corporation and Arthur Andersen. Enron defrauded thousands by intentionally inflating revenues that did not exist.

What is the significance of normal balances in maintaining accurate financial records?

For example, Lynn Sanders purchases a piece of equipment for $40,000. She believes this is a bargain and perceives the value to be more at $60,000 in the current market. Even though Lynn feels the equipment is worth $60,000, she may only record the cost she paid for the equipment of $40,000.

• Ed’s inventory would have an ending debit balance of $40,000 and a debit balance in cash of $15,000.
• They show a credit normal balance for retained earnings because they are part of equity.
• So, if a company takes out a loan, it would credit the Loan Payable account.
• You will learn more about the expanded accounting equation and use it to analyze transactions in Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions.

Identifying Normal Balances Across Account Types

By having many revenue accounts and a huge number of expense accounts, a company will be able to report detailed information on revenues and expenses throughout the year. Since cash was paid out, the asset account accounts and their normal balances Cash is credited and another account needs to be debited. Because the rent payment will be used up in the current period (the month of June) it is considered to be an expense, and Rent Expense is debited.

• Conversely, when a business takes out a loan, the loan liability account is credited, signifying an increase in liabilities.
• Revenue accounts show money made from business activities and have a credit balance.
• In order for companies to record the myriad of transactions they have each year, there is a need for a simple but detailed system.
• A solid understanding of debits and credits helps keep financial records clear and effective.
• An account with a balance that is the opposite of the normal balance.

For this reason the account balance for items on the left hand side of the equation is normally a debit and the account balance for items on the right side of the equation is normally a credit. The rest of the accounts to the right of the Beginning Equity amount, are either going to increase or decrease owner’s equity. This is because gain and revenue accounts normally have a positive account balance.

For example, a business might have certain expenses that are paid off (or reduced) over several time periods. If the business will stay operational in the foreseeable future, the company can continue to recognize these long-term expenses over several time periods. Some red flags that a business may no longer be a going concern are defaults on loans or a sequence of losses. In order to record a transaction, we need a system of monetary measurement, or a monetary unit by which to value the transaction.

• Without a dollar amount, it would be impossible to record information in the financial records.
• When you place an amount on the normal balance side, you are increasing the account.
• Meanwhile, expense accounts reflect costs in making revenue, typically having a debit balance.
• Understanding this is important for showing their value on the balance sheet.
• Whether you’re an entrepreneur or a seasoned business owner, understanding the normal balance of accounts is crucial to keeping your business’s financial health in check.
• If the payment was made on June 1 for a future month (for example, July) the debit would go to the asset account Prepaid Rent.
• This concept is called the separate entity concept because the business is considered an entity separate and apart from its owner(s).

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Role of Normal Balances in Financial Statements

When the value of assets increases, the asset account is debited, and when the value decreases, it is credited. This normal balance reflects the nature of assets as positive resources for the business, and any deviation from this norm can indicate an error or an unusual event that requires investigation. The relationship between normal balances and the categories of assets, liabilities, and equity ensures that the accounting equation remains in balance.