10. Determining Normal Balance for Shareholder's Equity

We've already done one video on determining normal balances, but in that one, we just looked at assets and liabilities. So this is gonna be part two of determining normal balances. You'll recall that when I say normal, I mean we're trying to figure out what the plus side of the account is. So in the last one, we looked at cash as an example, and we determined that the debit is the normal side. The debit is the side where you have your increases, and the credit is the side where you have your decreases. And most of what we did was look at the accounting equation and say, this is the left side, this is the right side.

And so for assets, debits are the normal side. For liabilities, if you've got something like accounts payable, we determined the normal side is the credit side 'cause it lives on the right side of the equation, while all this good stuff lives on the left side.

So in part one, we looked at assets and liabilities. We covered these two. Now, in this video, we're going to look at owner's equity. And if you'll recall, owner's equity is split out into retained earnings and contributed capital or stock.

Retained earnings is revenues minus expenses is net income, and you add the net income into the beginning retained earnings, and you take out dividends, minus dividends equals retained earnings, ending retained earnings. So retained earnings breaks down even farther to this equation.

So now let's start with contributed capital. Contributed capital is pretty easy. So it is a portion of owner's equity, as we've determined here. So if you see contributed capital, and the question says, let's say, contributed capital was increased by $1,000, and you have to come over here and write it into the account. Well, for contributed capital, it's pretty easy because we know, if contributed capital increases, owner's equity increases, right? Because owner's equity is retained earnings plus contributed capital. So owner's equity is just retained earnings plus contributed capital. So really, you could write it like this.

And then you can just say, "Okay, well, contributed capital lives on the right side, so contributed capital must be a normal credit account." And so you would say contributed capital is increased by $1,000, right? That one's not too difficult. Because an increase in contributed capital directly correlates to an increase in owner's equity, we do the whole right side, left side trick. So we say right side. Now, retained earnings is not much different. I'm not gonna spend too much time on this. Retained earnings is the same as contributed capital. An increase in retained earnings means an increase in owner's equity.

Because owner's equity is on the right side, retained earnings has a normal credit balance. Now, I told you we would talk about revenues and expenses, right? Now, here's the trick: revenues and expenses are not on the accounting equation anywhere, right? You don't see revenues and expenses here, so how are we supposed to be able to just figure it out like I've been telling you to do? Well, let me show you. So contributed capital, retained earnings. Retained earnings is revenues minus expenses equals net income.

Retained earnings plus net income minus dividends equals retained earnings, beginning and end. So way down here, these things kinda are in the accounting equation. They're not immediately visible. They are there. They do end up in the accounting equation under owner's equity, but it's not easy like, oh, assets, left side, cash, left side. Problem solved, move on. So this one's a little more tricky. So let's examine revenues, expenses, and dividends.

And I'll show you a couple of other ways to remember this kinda stuff, but I think this is the most important because you're learning. This will help you figure it out when your memory fails you. You can say, "Well, I actually learned this stuff, so let me just figure it out real fast." So we know that all three of these things, revenues, expenses, and dividends, eventually end up in owner's equity, right? So we know that at the end, they all flow down into owner's equity in one way or another.

We know that it all gets there. So let's look at revenue. If we have an increase in revenue, we have an increase in net income. That makes sense, right? Revenues minus expenses is net income. Increase in revenue, increase in net income. Easy enough. An increase in revenue is an increase in net income. An increase in net income is an increase in retained earnings, right? Because you've got retained earnings plus net income, minus dividends, equals retained earnings. So an increase in net income leads to an increase in retained earnings. An increase in retained earnings leads to an increase in owners' equity. So an increase in revenue is an increase in owners' equity.

How does that help us? Well, we know how to increase owners' equity. We've already gone over that somewhere up here. Owners' equity lives on the right side, and so to increase owners' equity, you put it on the right side. So to increase owners' equity is a credit. So an increase in owners' equity is a credit.

So if an increase in revenue leads to an increase in owners' equity, then an increase in revenue is a credit. So if you see a problem that says a company had $1,000 in sales, well, you know that that means sales went up by 1,000, sales revenue, so you need increase in revenue, and so you put it on the right side because an increase in revenue is an increase in owners' equity, and owners' equity is a credit account. Easy enough?

Now, let's work our way through expenses. An increase in expenses leads to a decrease in net income, which leads to a decrease in retained earnings, which leads to a decrease in owners' equity. So, as you probably could have guessed, revenue and expenses are opposite. An increase in expenses equals a debit.

Because if you increase expenses, what you're really doing is you're decreasing owners' equity, and to decrease owners' equity, you put it on the left side. So obviously, revenues and expenses are opposite. Now, let's figure out one more. Let's figure out dividends. An increase in a dividend is going to lead to what? Well, if dividends go up, then retained earnings is gonna go down. Let me put that on the other side. So an increase in dividends is a decrease in retained earnings, so increase in dividends, decrease in retained earnings, decrease in owners' equity.

So just like expense, where we have a decrease in owners' equity, you end up with dividends being a debit account because it's the opposite of owners' equity. So owners' equity is a credit account. Dividends, an increase in dividends means a decrease in owners' equity, so we swap these.

So as long as you can get back to owners' equity, you can figure out everything, 'cause it's either going to be an asset, a liability, or an owners' equity account. And revenues, expenses, dividends all flow into owners' equity.

So remember, left side, right side. Left means debit. Right means, I was gonna write right. Right means credit. So assets and liabilities, no problem. Owners' equity, no problem. So if you see retained earnings or contributed capital, those are both on the right, so we're gonna take care of those real quick. The things that we don't know, because they're not immediately visible here, is revenues, expenses, and dividends. Well, an increase in revenue eventually works its way down into an increase in owners' equity. So these two match, so we'll just say revenue is the same as owners' equity. Okay, what about expenses? An increase in expenses eventually works its way down into a decrease in owners' equity.

So we're gonna say expenses are the opposite of owners' equity. So owners' equity is credit, expenses are debit. What about dividends? Dividends, if we increase dividends, we're gonna have less owners' equity because we gave some money away, right? So we're gonna have less owners' equity, so we're gonna say dividends are also the opposite of owners' equity. Now, there are a couple of shortcuts to determining normal balances in case you forget just everything all at once, and we're gonna look at some of those shortcuts in another video.