Credit Balance Meaning
In accounting, the credit balance means the excess of the credit side of a ledger over the debit side. As per the fundamental accounting principles, ledgers accounts of liabilities, Incomes, Capital, Reserves, Provision, and Contra Expense tend to have a credit balance.
Ledgers Accounts of Credit Balance
Let’s discuss ledgers accountsLedgers AccountsLedger in Accounting, also called the Second Book of Entry, is a book that summarizes all the journal entries in the form of debits & credits to use for future reference & create financial statements. of credit balance for better understanding.
#1 – Liabilities
Liabilities are the dues arise from business transactions that the entity is obliged to honor. Liabilities account include:
- Current Liability such as trade payables, expense payable, bank overdraftOverdraftOverdraft is a banking facility that offers short-term credit to the account holders by allowing them to withdraw money from their savings or current account even if their account balance is or below zero. Its authorized limit differs from customer to customer., bills payable, short term debtShort Term DebtShort term loans are the loans with a repayment period of 12 months or less, generally offered by firms, individuals or entrepreneurs for immediate liquidity requirements. These are usually provided at a higher interest rate, these short term loans often have a weekly repayment schedule..
- Non-Current Liability such as secured loansSecured LoansA secured loan is one where the borrower pledges his/her assets as a collateral to the issuer as a security. In the event of nonpayment of the loan, the issuer has the right to sell or transfer the secured property in order to recover the balance owed., unsecured loans, bonds, debentures, deferred tax liability;
- Financial Instruments Payable such as call options, put optionsPut OptionsPut Option is a financial instrument that gives the buyer the right to sell the option anytime before the date of contract expiration at a pre-specified price called strike price. It protects the underlying asset from any downfall of the underlying asset anticipated., futures, forwards, swap instrumentsSwap InstrumentsSwaps in finance involve a contract between two or more parties that involves exchanging cash flows based on a predetermined notional principal amount, including interest rate swaps, the exchange of floating rate interest with a fixed rate of interest.;
The golden rule of bookkeepingBookkeepingBookkeeping is the day to day recording of financial transactions such as purchases, sales, receipts, and payments, and it is the first step in the accounting process. It can be prepared in two ways: single-entry and double-entry; however, the double-entry approach is more widely used and recognized in most countries. that applies to personal accounts requires to debit the receiver, credit the giver. Since most of the liability accounts are like personal accounts (accounts that pertain to individuals, firms, and corporates) by the said rule, they are recorded as a credit balance in the ledger account to indicate that amount owed by the entity.
ABC Inc. bought merchandise on 60 days’ credit from its suppliers. In this case, the supplier would have a credit balance in the books of ABC Inc., signifying the amount entity owed to its supplier.
Or, ABC Inc. raised long term funds by the issue of 6% 10-years bonds at par. In this scenario, ABC Inc. has raised funds from the public and is obligated to pay periodic interest payments as well as the repayment of principal at the end of 10 years. Hence the bondholders will have a credit balance in the books of ABC Inc.
#2 – Incomes
Incomes refer to the revenue and gains arises during the business from the operating as well as non-operating activities of the entity. The fundamental bookkeeping rule requires to debit all the transactions like expenses and credit all the transactions like incomes and gains. By the said rule, all revenue nature accounts such as sales, interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. , commissions, and brokerage income, capital gains due to the sale of assets or investments have a credit balance.
Let us say ABC Inc. holds 300 shares of Z Inc. as an investment. By the end of the year, Z Inc. declared a dividendDeclared A DividendDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities. of US $ 3 per share. Now, the dividend received from Z Inc. is an income in the hands of ABC Inc., and it will be credited in the books of accounts of ABC Inc.
#3 – Capital
Capital represents the money invested in the business by the founders, promoters, or shareholders in the case of a company, partners in the case of firm and owner in case of proprietorship. Again, by the book-keeping rule about personal accounts, capital balance such as paid-up capital, capital accounts, minority interestMinority InterestMinority interest is the investors' stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making. account has a credit balance as in books keeping, the owner and the entity are considered two separate identities and these accounts represent the amount the organization owed to the shareholder at the time of liquidation of the entity.
#4 – Reserves
Reserves refer to the retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. and accumulated profits of the entity such as general reserveGeneral ReserveGeneral reserve is the amount kept aside from the profit earned by the company during its normal course of the operation to meet future needs like contingencies, strengthening the company’s financial position, increasing working capital, paying dividends, offsetting specific future losses., capital reserveCapital ReserveCapital reserve is a reserve that is formed from the company's profits earned from its non-operating activities during a period of time and is retained for the purpose of financing the company's long-term projects or writing off its capital expenses in the future., capital redemption reserve, securities premium, etc. The Reserves also have a credit balance as just like a capital accountA Capital AccountThe capital account refers to the general ledger that records the transactions related to owners funds, i.e. their contributions earnings earned by the business till date after reduction of any distributions such as dividends. It is reported in the balance sheet under the equity side as “shareholders’ equity.”. These are the undistributed profits attributable to the stakeholders of the entity. The entity keeps reverses to support future expansions and obligated to distribute these profits to the stakeholders of the entity at the time of liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order..
#5 – Provisions
Provisions refer to the amount set aside from the profits to meet out any uncertain economic obligations of the future. Provisions are general non-cash expenses, i.e., do not involve the cash outflow at the time of recording and thus have a credit balance as they represent an amount set aside to meet any dues or liabilities that may arise in the course of business.
A general example of provisions is the provisions made for taxes. At the time of finalizing the books of accounts, it is difficult for the business to determine the amount due for taxes as the calculation of taxable incomeCalculation Of Taxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation. involves auditor’s opinion in case of tax audits and consideration of certain allowed or disallowed deductions as per the tax laws. Thus, at the time of finalizing its books of accounts, entities set aside an amount from its profits as provision for income taxes. As the amount did not involve any cash outflow at the time of recording the transaction, it is considered a liability indicating a future obligation that may arise.
#6 – Contra Expense Account
Contra Expense refers to the expense that set off a previous account of opposite nature.
For Example, ABC Inc. bought 100 units of t-shirts at the US $ 25 per t-shirt for the purpose of reselling the merchandise. To record this business transactionBusiness TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements. in the books of accounts, ABC Inc. debited the purchases account by the US $ 2,500, which indicates the cost of 100 t-shirts charged as an expense.
However, later the manager realized that 15 t-shirts were of inferior quality and immediately returned the same to the supplier. Now, in this case, it is important to reduce the total cost of 100 t-shirts by the cost of 15 t-shirts, which are returned as per the matching principle of accounting. Thus, ABC Inc. will credit the US $ 375 in the purchase return account to offset the amount debited in the purchase account. In this case, Purchase Return is a contra expense account and have a credit balance.
Credit balances in the books of accounts are generally referred to as the amount that the entity has earned as income or dues and liabilities which the entity is obligated to honor at the time of maturity.
This has been a guide to what is credit balance and its meaning. Here we discuss the top 6 ledgers accounts of credit balance like Liabilities, Incomes, Capital, Reserves, Provisions, Contra Expense Account along with the example. You can learn more about accounting from the following articles –