Meaning of Trial balance
After the transactions are posted to various accounts (from journal or subsidiary books) and they are balanced, the next step is to prepare a list of all balances.
We know that some ledger accounts will show that debit balance (more debit side than credit side), while another will reflect credit balance (credit side being higher than the debit side).
All account balances are listed to ensure that all debit balances are equal to the total credit balance.
Why does this happen? We called the dual aspect concept which discusses in the previous post of my blog. In this concept, each debit side has the same credit side. That we called a trial balance.
Trial Balance Definition:
According to the Dictionary for Accountants by Eric. L. Kohler, Trial Balance is defined as “a list or abstract of the balances or of total debits and total credits of the accounts in a ledger, the purpose being to determine the equality of posted debits and credits and to establish a basic summary for financial statements”.
According to Rolland, “The final list of balances, totaled and combined, is called Trial Balance”.
As this is only a list of balances, it will be as usual on a particular date. Further, it should be understood that the trial balance is not a part of the books of account, but it is a report prepared by taking out the balance of accounts created in the books of accounts.
When this list is prepared with tallied debit and credit balances, the arithmetic accuracy of the basic entries, ledger, and balance is ensured. However, this does not guarantee that the entries are correct in all cases. We will discuss it later.
Although it must be prepared at the end of the accounting period, computerized accounting packages are capable of providing immediate trial balance reports even on a daily basis, as transactions are recorded almost on the line.
Let us prepare the trial balance for the ledger balances:
- Cash in Hand-----Rs. 1,000
- Cash at Bank-----Rs. 4,000
- Building----------Rs. 60,000
- Investments in 7% G.P.Notes----------Rs. 40,000
- Donations--------Rs. 60,000
- Billiards table----Rs. 40,000
- Outstanding Subscriptions-------------Rs. 3,700
- Gardening & Upkeep Costs-----------Rs. 28,000
- Admission Fees--Rs. 15,000
- Accumulated Fund--------Rs. 1,01,700
It can be seen that the totals of debit and credit balances are exactly matching. This is the result of double-entry book-keeping wherein every debit has equal corresponding credit.
Features of a Trial Balance:
1. This is a list of debit and credit balances that have been extracted from various ledger accounts.
2. This is a statement of debit and credit balance.
3. It is intended to establish the arithmetic accuracy of transactions entered into books of accounts.
4. It does not prove the arithmetic accuracy that can be determined by an audit.
5. This is not an account. This is only an account statement.
6. Trial Balance is not part of the final statements.
7. It is usually prepared at the end of the accounting year, but it can be prepared weekly, monthly, quarterly, or half-yearly at any time if required.
8. It is a link between books of accounts and profit and loss account and balance sheet.
Purpose of a Trial Balance:
It serves the following purposes:
1. Check the arithmetic accuracy of recorded transactions.
2. To find out the balance of any ledger account.
3. Serve as proof of the fact that double-entry is complete in relation to every transaction.
4. Facilitate preparation of final accounts immediately.
How do you prepare a Trial Balance?
1. It can be prepared on a loose sheet of paper.
2. The ledger is balanced at first. They will have debit-balance or credit-balance or nil-balance.
3. Debit-balance accounts are written on the debit column and credit-balance holders are written on the credit column.
Each debit has its own corresponding and equal credit, the sum of both balances must be equal.
- Read Also: Accounting Inventory |Net realisable value
- Read Also: Accounting Journal| Cash Book| Its Types
Is Trial Balance indispensable?
This is the only statement prepared by accountants for their convenience and if it agrees, it is assumed to have at least arithmetic accuracy, although there may be a lot of errors.
The trial balance is not a process of balancing accounts, but its preparation helps us in finalizing the accounts.
Since it is prepared on a particular date, as at ........ / as on......
Forms of a Trial Balance:
A trial balance may be prepared in two forms, they are:--
- Journal Form
- Ledger Form
1. Journal Form: This form of trial balance will have the format of a journal folio.
This journal form will have a column for a serial number, account name, ledger folio, debit amount, and credit amount column. The ledger folio will show the page number on which the account appears in the ledger.
Trial Balance format in the Journal form :
2. Ledger Form: This form of trial balance has two sides ie the debit side and the credit side. In fact, the account balance of the trial balance is prepared as an account.
Each side of the trial balance will have a particulars (account name) column, folio column, and amount column.
Trial Balance format in the Ledger form :
What are the three types of trial balances?
- Total Method or Gross Trial Balance.
- Balance Method or Net Trial Balance.
- Compound Method.
1. Total method or gross trial balance: Under this method, two aspects of the accounts are total. The debit side's total is called the debit total and the credit side's total is called the credit total.
The debit balance is recorded on the debit side of the trial balance while the credit is recorded on the credit side of the total trial balance.
If a particular account has one side total, it will be recorded in the debit column or credit column as the case may be.
Advantages:
(a) It facilitates the arithmetic accuracy of accounts.
(b)Extraction of ledger balances is not required at the time of preparation of Trial Balance
Disadvantages:
(a) Preparation of final accounts is not possible.
2. Balance Method or Net Trial Balance: Under this method, all ledgers are balanced. The remaining balance can be either debit side balance or credit side balance.
Advantages:
(a) Preparation of final accounts is very easy with the help of trial balance.
(b) Saves time and labor in preparing of trial balance.
Disadvantages:
(a) Errors may remain unknown despite the agreement of the remaining trial balance.
3. Compound method: Under this method, accounts of both parties are written in separate columns.
In addition, the remaining columns are also written in separate columns.
The debit balance is written in the debit column and the credit balance is written in the credit column of the trial balance.
Advantages:
(a) It provides the benefit of both methods.
Disadvantages:
(a) Long process and more time are consumed in preparing a trial balance.
Summary of trial balance Rules:
Debit Balance -- All assets, Drawings, Debtors, Expenses, and Losses.
Credit Balance -- All liabilities, Capital, Creditors, Gains, and Incomes.
Trial Balance - utility and interpretation
The utility of the trial balance can be found in the following:
(1) It forms the basis for the preparation of the financial statement i.e. profit and loss account and balance sheet.
(2) Arithmetic accuracy of entries made by tallied trial balance is ensured.
If the trial balance is not tally, errors can be detected, corrected and then financial statements prepared.
(3) It serves as a quick reference. In fact, the balance can be easily ascertained in any ledger.
(4) If the books of accounts are arranged systematically in the trial balance, the person can do a quick time analysis.
Therefore, listings are usually done in a sequence of asset accounts, liability accounts, capital accounts, owner's equity accounts, income or profit accounts, and expense or loss accounts in that order.
One can draw some quick conclusions from the trial balance by explaining the same.
If the monthly trial balance is balanced by one party, the individual can analyze the movement of the balance in different accounts.
One can see how expenses are increasing or decreasing or showing a tendency for movements. By comparing the two dates, the owner's equity balance, the individual can interpret the business result.
If equity has increased, one can interpret that the business has made a net profit and vice versa.
Errors which are revealed by a Trial balance/Advantages of a Trial Balance:
No financial statement can be prepared if the trial balance is not tally. Therefore, errors must be corrected before proceeding.
Therefore, accountants try to reduce errors by being more careful and periodically checking entries.
If the trial balance does not tally, there may be errors in the transaction entry. Such errors are called errors affecting trial balance. These can be:
(a) Only one effect of the transaction is posted to the ledger. For rent paid in cash, if the entry is posted in cash but not to the rent account, then obviously trial balance will not match.
(b) Posting of the wrong amount in a ledger e.g. A electricity of Rs 2,500 is paid in cash. Posting for Electricity A / C Rs. 2,500, Cash A / C is recorded at Rs. 25,000. Then the trial balance will not tally.
(c) If a posting is filed twice in the trial balance. It will not match.
(d) Balancing the wrong side in the trial balance. Such as a debit balance of Rs. 500,000 in Debtors A/c is taken as a credit balance in the trial balance, then there will be a mismatch.
(e) The Wrong Carry Forward will also cause a mismatch in the trial balance.
Errors not revealed by Trial Balance/Limitations of a Trial Balance:
Errors that have not been disclosed by trial balance The following errors cannot be detected by trial balance:
(a) Errors of Omission: When the transaction is not recorded in the books of accounts, i.e. neither on the debit side nor on the credit side of the account - the trial balance will be agreed.
(b) Errors of Commission: Where there is any variation in the figure/amount, e.g. instead of Rs.800 either Rs. 80 or Rs, 8,000 is recorded, in both sides of the ledger accounts -the trial balance will be agreed.
(c) Errors of Principle: When accounts are prepared in accordance with the double-entry principle such as the purchase of Furniture wrongly Debited to Furniture A/c - the trial balance will be agreed.
(d) Errors of Misposting: When wrong posting is done in a wrong account instead of a correct account, although the amount is entered correctly, eg, goods are sold to B, but wrongly in D's account is debited - the trial balance will be agreed.
(e) Compensating Errors: When one error is compensated by another error. Such as Discount Allowed Rs. 100 not debited to the Discount Allowed A/c, while interest Rs. 100, but not credit to Interest Account - trial balance will be agreed.
How to fix trial balance errors, Or, Steps to be taken if the Trial Balance does not agree:
If the Trial balance does not agree, the following procedure should carefully be following:
(i) First of all, check all ledger accounts one by one.
(ii) The addition of both columns (debit and credit) should be checked.
(iii) If any difference is divided by 2 and see whether the said figure appears on the right side or not.
(iv) Subsidiary books and additional accounts should be checked.
(v)Check ledger posting from subsidiary books.
(vi) Whether the opening of the balance of all accounts is brought forward properly or not should be investigated.
(vii) Even if the trial balance is not agreed to this level, the original entry of the tick mark must be resumed from the journal and book.
What is a Suspense Account why is it opened and how is it closed in books of account?
In order to locate the cause of disagreement of a Trial balance, a thorough checking is necessary for the books of account.
After several checking and re-checking if the Trial balance does not agree, then it is transferred to the Suspense Account or Difference in Books Account.
After the detection of errors, they are rectified and the Suspense Account is closed.
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