Normal balance of accounts: the five types and the exceptions

Before you can debit or credit an account, you need to know what kind of account it is. Learn how to read an account name, place it in one of five types, and give it the right normal balance, including the contra accounts that break the pattern.

The five account types

Every account in a chart of accounts belongs to one of five types. The chart of accounts is simply the list of every account a business uses, each with a name and usually a number.

• Assets are what the business owns or is owed: Cash, Accounts Receivable, Notes Receivable, Supplies, Equipment, Buildings, Land.
• Liabilities are what it owes: Accounts Payable, Notes Payable, Sales Tax Payable, Unearned Revenue, Bonds Payable.
• Equity is the owner's claim: Owner's Capital and Owner's Drawing.
• Revenue is what the business earns by doing its work, plus other gains: Sales Revenue, Service Revenue, Interest Revenue, Gain on Sale of Equipment.
• Expenses are the costs of earning that revenue, plus other losses: Rent Expense, Cost of Goods Sold, Depreciation Expense, Loss on Sale of Equipment.

The first three types make up the accounting equation, Assets = Liabilities + Owner's equity. Revenue and expenses are really parts of equity that are kept separate during the year so the business can measure its profit. If the equation itself is new to you, start with accounting equation practice.

What "normal balance" means

An account's normal balance is the side on which it increases, and so the side where its balance usually sits. Debit means left; credit means right.

The pattern follows the equation. Assets sit on the left side, so they increase on the left. Liabilities and equity sit on the right, so they increase on the right. Revenue adds to equity, so it behaves like equity. Expenses take away from equity, so they behave the opposite way. The page on journal entry practice problems walks through those rules with T-accounts and full entries. This page focuses on the step before that: working out the type from the name.

How to read an account name

Most account names tell you their type if you know what to look for. Ask these questions in order:

1. Does the name end in "Payable"? Then it is a liability: the business owes it.
2. Does it end in "Receivable"? Then it is an asset: someone owes the business.
3. Does it end in "Expense," or name a cost or a loss? Then it is an expense.
4. Does it end in "Revenue," or name a gain? Usually revenue, with one important exception, Unearned Revenue, covered below.
5. Does it name the owner? Then it is equity.
6. Is it something physical or prepaid? Cash, Supplies, Prepaid Rent, Equipment, Buildings and Land are all assets.

Then ask one more question: does this account reduce another account? If it does, it is a contra account, and its normal balance flips.

Worked example: Northside Print Shop

Northside Print Shop is setting up its chart of accounts. For each account, choose its type: asset, liability, equity, revenue or expense.

1. Miscellaneous Expense. The name ends in "Expense." It collects small costs of running the business that don't have their own account. Expense.
2. Cost of Goods Sold. No "Expense" in the name, but it is the cost of the products the business sold. It is used up in earning sales revenue. Expense.
3. Sales Revenue. Earned by selling products to customers. Revenue.
4. Interest Revenue. Earned on money the business has lent or deposited. It is not the main line of business, but it is still earned. Revenue.
5. Unearned Revenue. The trap in the list. A customer has paid before the work is done, so the business owes the customer the work. That is a debt. Liability.
6. Freight-In. The shipping cost of bringing purchased goods in. It becomes part of the cost of the goods, and that cost ends up in Cost of Goods Sold. Expense.

The first exercise asks only for the type. The normal balance column is added here so you can see how it follows from the type once the type is right. Unearned Revenue has a credit balance either way, which is why classing it as revenue is so easy to miss: the side is right, but the type is wrong.

Contra accounts: the exceptions

A contra account is an account that reduces another account. It belongs to the same type as the account it reduces, but it carries the opposite normal balance. Keeping it separate lets the business show both the original figure and the reduction.

Take Accumulated Depreciation. Equipment is recorded at its cost and stays there. Each year's depreciation builds up in Accumulated Depreciation instead. The balance sheet then shows the cost, minus the accumulated depreciation, to give the carrying amount. Because it reduces an asset, it is classed as an asset with a credit balance. The depreciation journal entry page shows the entry that builds it up, and the allowance method for bad debts does the same for the allowance.

Owner's Drawing works the same way inside equity. It records what the owner takes out, so it reduces Owner's Capital and carries a debit balance.

A second example: Copperleaf Studio

The second exercise asks for both the type and the normal balance. Here is Copperleaf Studio's list with the answers:

Four of the eight are exceptions to the plain rule. Allowance for Doubtful Accounts, Owner's Drawing, Discount on Bonds Payable and Purchase Returns and Allowances are all contra accounts. Sales Tax Payable is ordinary: the business collected tax from customers and owes it on, so it is a liability with a credit balance.

Common mistakes and how to avoid them

The exercises watch for these mistakes and explain each one when it happens.

Classing Unearned Revenue as revenue

The word "Revenue" in the name pulls learners toward the revenue type. But nothing has been earned yet. The customer has paid, and the business still owes the work. Until the work is done, Unearned Revenue is a liability. When the work is done, an adjusting entry moves the amount into revenue; the unearned revenue adjusting entry page shows how.

Classing Owner's Drawing as an expense

Drawing has a debit balance, like an expense, and it reduces equity, like an expense. But it is not a cost of running the business. The owner is taking money out for personal use, and that earns nothing. Owner's Drawing is equity with a debit balance.

Giving every account a debit balance

Some learners mark every account as a debit, perhaps because assets and expenses come up most. Liabilities, Owner's Capital and revenue all normally carry credit balances. Only assets, expenses and contra accounts such as Owner's Drawing carry debits. If your column is all one side, look again.

Giving contra accounts their type's usual side

This is the most common slip with contra accounts. Accumulated Depreciation is an asset, so it is tempting to mark it as a debit. But it reduces an asset, so it carries a credit. The same goes for the Allowance for Doubtful Accounts. Always ask whether the account adds to its type or takes away from it.

Classing Accumulated Depreciation as a liability

Accumulated Depreciation has a credit balance, and liabilities have credit balances, so the two get mixed up. But the business doesn't owe anyone its accumulated depreciation. It is a contra asset that lowers the carrying amount of equipment or buildings.

How to check your answers

• Say the account out loud as a sentence. "The business owes this" means liability. "The business owns this, or is owed it" means asset.
• Look for the word "Payable" or "Receivable." These rarely mislead.
• Distrust the word "Revenue" when "Unearned" comes before it.
• Ask whether the account reduces another. If it does, keep the type and flip the side.
• Count your credits. A real chart of accounts always has both debit and credit accounts. Every liability, the capital account and every revenue account sit on the credit side.

Once you can sort accounts by type and side, the next step is to place each one on its financial statement, covered in chart of accounts classification.