A trial balance is a great tool that accountants use to ensure their credits and debits are balanced for a financial statement or auditing adjustments.
But why would a company need to keep track of all the balances in its ledger accounts? What role does a trial balance play in the growth of a business? Read on to find out more about this feature in accounting.
Before we delve deeper into the topic, let us first answer the question, ‘what is a trial balance?’
Trial Balance Definition
It’s a statement of all credits and debits. Moreover, it is considered the first step towards the preparation of financial statements. Trial balance can be generated by hand or automatically via a computerized accounting system.
As an accounting period draws to an end, trial balances list all major accounting items, including liabilities, expenses, gains, revenues, equity, assets and losses. After balancing all accounts, the total of the debit balances should always equal the sum of the credit balances. A disparity signifies an error that must be found and fixed.
There are three types of trial balance reports available. The key distinction between these three trial balances is the type of adjustments that accountants must make before the accounting period is concluded. They are:
An unadjusted trial balance is a financial report that is generated prior to the adjustment entries being recorded. It’s a critical aspect of completing a full set of financial statements. The unadjusted trial balance is the initial statement of ledger account balances prepared without any period-end modifications.
It gives a summary of the ledger account balances, such as inventory accounts and sales accounts.
The adjusted trial balance includes revenue and expense balances and asset, liability, and equity balances. It’s created after all of the adjustments have been made at the end of the accounting period.
The post-closing trial balance is created after all of the closing entries have been registered and published. It is prepared before the new accounting cycle begins. The post-closing trial balance’s main objective is to verify that debits and credits are balanced.
Components of a Trial Balance
The general structure of a trial balance accounting worksheet is the same. Accountants use the double-entry approach to log all activity in their accounting records. The phrase “double-entry system” alludes to the twofold entries businesses record into the pairs of accounts.
Every transaction involves specific types of monetary exchanges between at least two business accounts. Companies make a debit or credit entry to a report based on the account type to raise or decrease an account. The balance of each account rises or drops depending on the case.
The trial balance sheet features several components. Some change along the way, while others remain somewhat the same throughout. Item sections you will find on a trial balance include:
- Company name – Helps identify specific branches in cases where a corporation is divided into subsidiaries. This enables accountants or auditors to remember the particular division the trial balance represents.
- List of accounts – Usually found on the left-hand side of the sheet, all company accounts are compiled. Most businesses follow the order of assets, liabilities, equity, dividends, revenues, and expenses. The list must remain constant in all trial balance documents to maintain uniformity and for more accessibility.
- Balances – They are located on the opposite end of the list of accounts. Two columns are usually featured, with the left column containing debit balances and the right column containing credit balances. However, some businesses go the non-traditional route only using one column. Debit balances are represented by positive numbers, while credit balances are expressed as negative figures.
Undetectable Errors in a Trial Balance
A common misconception is that a trial balance can detect all kinds of errors. The fact is, there are inevitable mistakes that can go undetected. Some faults that are easily exposed by a Trial Balance sheet include:
- There is a disparity in tallying the debit and credit values of the trial balance, meaning there’s an error.
- In the overall number of subsidiary books, there is an error.
- The accountant entered the amount of subsidiary books incorrectly in the ledger.
- Omitting an account balance in the Trial Balance.
Other types of errors may go undetected in this accounting process. A bit more intervention is required to identify and rectify them. Let us take a look at some of them.
Error of principle
These are mistakes that go against the fundamentals of book-keeping. For instance, it should be listed under a Purchase Account when you make office stationery purchases rather than a Stationery Account.
Error of omission
It occurs when a transaction is unrecorded or fails to post in the ledger.
The error of original entry
It includes a double-entry transaction that defines the wrong amounts on both the debit and credit sides.
Error of reversal
It happens when you input a correct figure but place it on the wrong side of the sheet.
Picture this scenario: On a ledger, you debit an account with $1000 less and credit another $1000 less too. In the end, the error is neutralized because there is an equal mistake on both sides.
Error of Amounts in Original Book
These are minor errors that do not affect the arithmetic accuracy of the trial balance. For example, the trial balance will be correct if an invoice numbered Bx 396 is recorded as Bx 369 in the sales book, although the invoice’s title is incorrect.
The Difference Between a Trial Balance and a General Ledger
Anyone involved in book-keeping or accounting knows the critical differences between a definition trial balance and a ledger. Distinctions are based on:
A trial balance is a compilation of all accounts and their CYTD (Current Year-to-Date) ending balances. A general ledger is a list of all accounts that shows the accounts and transactions that occurred during the CYTD.
Type of information represented
A trial balance is a report which derives all information from the general ledger balances. It is merely a report derived from the general ledger. In contrast, the ledger is regarded as a database of information regarding accounting transactions for use in a detailed financial analysis of a company for a particular period.
Amount of information
Only the closing balance of each general ledger account is presented in the trial balance. On the other hand, General Ledger offers ample transaction records for each account created or outstanding in the company throughout the accounting period.
A trial balance just checks if the totals of all credits and debits are balanced. In contrast, ledgers are used to track balances down to individual transactions to investigate accounts.
Requirements for a Trial Balance
So, what is required for a trial balance to be accurate? Here are a few requirements to help you learn how to create a trial balance successfully:
- Accounts in the ledgers could have been debited or credited during a given accounting period before being used in a trial balance worksheet.
- The expense, asset, or loss accounts should each have a debit balance, and the statements of equity liability, gain, or revenue should each have a credit balance.
- Ensure the total debits equal the total credits
Example of a Trial Balance
Here is an example of a recently completed trial balance example from a furniture manufacturing company:
The Bottom Line
A trial balance report is essential for interpreting the financial results of any business—whether you’re a start-up or an established multinational corporation.