A trial balance is a memorandum listing all account balances as an internal check on the mathematical accuracy of double-entry bookkeeping. It has two columns, debit and credit, and these two columns should be equal to each other indicating there is no arithmetical error.
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A list of balances is made from the ‘Receivables Ledger’ and ‘Payables Ledger’ to determine total receivables and total payables amounts for inclusion in it. The source of balances for preparing it consists of:
- Bank and Cash balance from cash book
- The balance receivable from the list of balances (whether from the receivables ledger or the general ledger if a separate receivables ledger is not maintained).”
- Payables balance from list of balances (payables ledger, or general ledger if separate payables ledger is not maintained)
- All other balances from the general ledger
Types
There are three main types:
- The unadjusted
- The adjusted
- The post-closing
All three of these types have the same format but slightly different uses. The unadjusted balance is prepared on the fly before adjusting journal entries are completed. It is a record of day-to-day transactions and can be used to balance a ledger by adjusting entries.
Once a book is balanced, an adjusted balance can be completed. It has the final balances in all the accounts, and it is used to prepare the financial statements. However, The post-closing trial balance shows the balances after the closing entries have been completed. This is your starting trial balance for the next year.
Purposes
The purpose of a trial balance is to ensure the accuracy and completeness of a company’s accounting records. It serves several key objectives:
- Error Detection: By listing all the debit and credit balances from the general ledger, a trial balance helps identify errors such as mathematical mistakes, data entry errors, or incorrect posting to accounts. If the trial balance does not balance, it signals that there may be errors in the accounting records.
- Verification of Accuracy: It verifies that the total debits equal the total credits, which is a fundamental requirement of double-entry accounting. This ensures that the accounting equation (Assets = Liabilities + Equity) is in balance, providing a basic check on the overall accuracy of financial statements.
- Preparation for Financial Statements: The trial balance serves as a preliminary step in the preparation of financial statements. Account balances from it are transferred to financial statements like the income statement and balance sheet, helping to ensure that the information presented in these statements is based on accurate and complete data.
- Internal Control: It is a tool for internal control within a company. It helps in identifying irregularities and discrepancies in the accounting records, which can be investigated and corrected to maintain the integrity of financial reporting.
- Assistance in Adjusting Entries: When preparing financial statements, adjusting entries may be necessary to recognize certain transactions that have occurred but are not yet reflected in the ledger. The balance can help in identifying the accounts that need adjusting entries.
- Financial Reporting: Ultimately, It contributes to the preparation of financial reports that stakeholders, including investors, creditors, and management, rely on to make informed decisions about the company’s financial health and performance.
Limitation of a Trial Balance
The balance is taken as a test of arithmetical accuracy. If both the debit and credit columns of the trial balance are equal to each other, we assume that there is no mistake in the posting of journal and subsidiary books to ledger accounts, in carrying forward balances of ledger accounts to trial balance, and even in the balancing of ledger accounts.
This assumption is correct but should never be taken as conclusive proof of accuracy. It means that certain errors remain undetected by it. Both the debit and credit columns of the trial balance may be equal despite certain mistakes of omissions and principles. These errors may be mentioned as under:
- Errors of omission in the books of the original record
- Errors of principle (posting on the right side of the wrong account nature-wise)
- Compensating errors (same amount effect on debit and credit side)
- Incorrect account in the original books (on both sides)
- Posting to the wrong account (but on the right side)
Frequently Asked Questions
Why is a trial balance prepared?
A trial balance is prepared to check the accuracy of accounting records, ensure that total debits equal total credits, and provide a foundation for the preparation of financial statements.
What does it mean if a trial balance doesn’t balance?
If a trial balance doesn’t balance (total debits do not equal total credits), it indicates that there are errors in the accounting records, such as data entry mistakes, unrecorded transactions, or incorrect postings.
When is a trial balance usually prepared?
A trial balance is typically prepared at the end of an accounting period, such as monthly, quarterly, or annually, to coincide with the preparation of financial statements.
What are the steps to prepare a trial balance?
To prepare the balance, you need to list all ledger accounts and their balances, separate debits and credits, and then add up the totals for each side (debits and credits).
What are the types of errors that a trial balance can detect?
A balance can detect errors like transposition errors (reversing digits when posting amounts), omission of transactions, and arithmetic mistakes.