Double Entry Accounting and Natural Account Balances Made Easy
The most basic concepts that you need to understand in accounting are the concepts of double entry accounting and natural account balances. For many these concepts are like a foreign language when they first start an accounting curriculum. I remember when I started my accounting education that this made a lot of sense, but there were others in my class who struggled at first to remember these concepts. Eventually, anyone who wants to succeed and move onto more complex rules needs to master double entry accounting and natural account balances to the point that it is second nature. In this article I will present why these concepts, some ways to easily remember them, and why they are important.
Double Entry Accounting
In double entry accounting all entries into the accounting system have two sides—the debit and the credit. These two sides should net to zero. If they do not the entry is out of balance meaning that something is incorrect.
Debits and credits serve as what you might call the positive and negative because when consolidate into a single column you would use a positive number to represent the debit and a negative number to represent the credit. Oftentimes, I think this association is something that most people who have difficulty with, which brings us to natural account balances.
Natural Account Balances
Natural account balances are the balances you would expect to see for a certain account type during normal activities and with proper accounting. When you see an unnatural balance in an account it can be a sign of an improper entry or the need to reclassify the balance due to the underlying cause or activity.
Assets and expenses have debit natural account balances. This means that during a journal entry these balances would be increased by a debit or “positive” entry. Liabilities, net assets, and revenues have credit natural account balances. This means that during a journal entry they are increased by a credit or “negative” entry. The revenue and net assets natural account balances are those that I have most often seen misunderstood by students and others new to accounting.
The easiest way to understand how this all works is through visualization. I would never fault anyone for writing out and entry to two column format to get to the correct entry and make sure that the entry balances. So, let’s take a look at some examples that I think will help you get a better grasp on the double entry accounting and natural account balances concept.
You may note that we have not made any entries to net assets. This is because net assets are a product of the difference between expenses and revenues plus the prior year net assets. One mistake I have seen numerous times is an entry to record revenue which then debits (or decreases) net assets or an entry to cash and net assets (which fails to record revenue) to record the restriction. Restricted net assets instead should be broken out by an entry to Net Assets without Donor Restriction and Net Assets with Donor Restrictions for the change during the period. Preferably you would only make this entry at the end of an accounting period rather than with every transaction.
It is important to understand double entry accounting and natural account balances to excel as an accountant or bookkeeper. Sometimes it is best to go back to the basics and build from there when working on a complex entry or reviewing the financial statements. By having a firm understanding of natural account balance you will be prepared to identify potential errors or special situations when reviewing the financial statements. This understanding will also help you to avoid mistakes when recording transactions. If you do not have a firm understanding of these concept, I suggest you practice to become proficient.