Credit balances

Understanding Credit Balances in Accounting

In double-entry bookkeeping, every account has two sides: debit (left) and credit (right). A credit balance exists when the credit side total is greater than the debit side total. This concept is fundamental to preparing accurate financial statements and understanding your business’s financial health.

Think of credit balances as amounts your business owes to others or has earned. For example, if you buy goods from a supplier on credit, the supplier’s account shows a credit balance until you pay. Similarly, when you make sales, the sales account builds up a credit balance showing your income.

Types of Accounts with Credit Balances

Liability Accounts

Liability accounts always have credit balances under normal circumstances. These represent what your business owes to external parties. When you borrow money from Access Bank or buy goods from a supplier on credit, these create credit balances.

Examples include:

• Accounts Payable: Money owed to suppliers for goods bought on credit
• Loans Payable: Bank loans or personal loans to the business
• Accrued Expenses: Expenses incurred but not yet paid (salaries, rent)
• Unearned Revenue: Money received before providing goods or services

Capital Accounts

The owner’s capital account shows a credit balance representing the owner’s investment in the business plus accumulated profits minus drawings. This balance shows the owner’s claim on business assets.

When Mr. Adeyemi invests ₦500,000 to start a business, his capital account is credited with ₦500,000. If the business makes ₦150,000 profit in the first year, the capital account increases to ₦650,000 (still a credit balance).

Income and Revenue Accounts

All income accounts carry credit balances. These include sales revenue, commission received, discount received, rent received, and interest received. The credit balance shows how much the business has earned during the accounting period.

How Credit Balances Work

Let’s examine how credit balances increase and decrease using a practical example:

Example: Chioma’s Boutique buys clothes worth ₦80,000 from a Lagos supplier on credit.

The remaining ₦40,000 credit balance shows Chioma still owes the supplier. When she pays the balance, the account will be cleared (zero balance).

Credit Balances vs. Debit Balances

Credit Balances in the Trial Balance

The trial balance lists all ledger account balances at a specific date. Credit balances appear in the credit column on the right side. The total of all credit balances must equal the total of all debit balances if the books are correctly maintained.

A typical trial balance might show:

Balancing Accounts with Credit Balances

At the end of an accounting period, you must balance all accounts. For accounts with credit balances:

1. Add up both debit and credit sides separately
2. Find which side is larger (for credit balance accounts, credit side is larger)
3. Write “Balance c/d” (carried down) on the debit side for the difference
4. Total both sides – they should now be equal
5. Bring down the balance on the credit side as “Balance b/d” (brought down)

Common Exam Mistakes

Practice Questions

Multiple Choice Questions

1. Which of the following accounts normally has a credit balance?
   • Cash account
   • Drawings account
   • Accounts payable ✓
   • Rent expense
2. When an account has a credit balance, it means:
   • The debit side total exceeds the credit side total
   • The credit side total exceeds the debit side total ✓
   • Both sides are equal
   • The account is in error
3. In a trial balance, credit balances appear in the:
   • Left column
   • Right column ✓
   • Middle column
   • Footer section
4. If a supplier’s account shows a credit balance of ₦45,000, it means:
   • The supplier owes us ₦45,000
   • We owe the supplier ₦45,000 ✓
   • We paid the supplier ₦45,000
   • The supplier paid us ₦45,000

Essay/Theory Questions

1. Explain four types of accounts that normally carry credit balances. (8 marks)
   
   Tip: Identify the account type, explain why it has credit balance, and give one example for each.
2. The following transactions occurred in Emeka’s business during March 2024:
   • March 1: Started business with ₦300,000 cash
   • March 5: Bought goods on credit from Ojo Stores ₦80,000
   • March 12: Sold goods for cash ₦50,000
   • March 20: Paid Ojo Stores ₦30,000
   • March 28: Received commission ₦15,000

   Required: Identify all accounts that would have credit balances at March 31 and state the amount of each balance. (10 marks)
   
   Tip: Set up T-accounts for each item, post entries correctly, then balance accounts to identify credit balances.

3. Distinguish between a credit balance and a credit entry, giving two examples of each. (8 marks)
   
   Tip: Define each term clearly, explain the difference, then provide practical examples showing credit entries that create credit balances.

Memory Aids

Remember account types with ALICE:

• Assets = Debit balance
• Liabilities = Credit balance ✓
• Income = Credit balance ✓
• Capital = Credit balance ✓
• Expenses = Debit balance

For balancing accounts, remember “CDB”:

• Carried down on opposite side
• Draw a line and total both sides
• Bring down on the original side

Related Topics

• Debit balances in accounting
• Double entry bookkeeping system
• Trial balance preparation
• Balancing of accounts
• Classification of accounts (personal, real, nominal)