Before preparing financial statements at the end of a period, the books must be balanced, i.e. to determine total debits equal total credits. This is determined by preparing a trial balance.
A Trial Balance is a list of accounts and their current balances at a given date. It is usually prepared on the last day of the accounting period and the list of account balances are arranged according to debit and credit balances.
Debit balances are listed in one column and credit balances are listed in another. The two column totals should be equal. When this occurs, the ledger is said to be in balance.
The primary purpose of a Trial Balance is to prove the mathematical equality of debits and credits in the ledger. According to the double-entry system of recording, if a debit and a credit have been made for each transaction, the total of the debits should be equal to the total of the credits. If the accounts are balanced off and their balances compared, the total of debit balances should be equal to the total of credit balances.
In addition, the Trial Balance is useful in the preparation of the Trading and Profit and Loss Accounts, and the Balance Sheet since it lists all the account balances in the ledger.
To check the arithmetic accuracy, i.e. The debit totals and the credit totals should be equal if the double- entry system of book-keeping is followed.
To write up the financial statements, i.e. Trading and Profit & Loss Accounts, and Balance Sheet.
Although the Trial Balance is used to prove the accuracy of the double-entry system of recording, it has its limitations.
A Trial Balance that balances does not prove that all the transactions have been recorded or that the ledger is correct. This is because numerous mistakes may exist even though the Trial Balance totals are in agreement.
Errors can be classified into two categories -
The following errors do not affect the equality of the Trial Balance totals:
Errors of Omission: A transaction is omitted completely from the books so that there is no debit and credit entry of the transaction, e.g. Drawings of $50 cash by the proprietor was not recorded.
Errors of Commission: An entry is posted to the correct side of the ledger but to the wrong account, i.e. items have been posted to the wrong account of the same class, e.g. Payment of $100 cash by a customer A. John was wrongly posted to the account of another customer, B. Johan.
Errors of Principle: An entry is made in the wrong class of account, i.e. when an expense is treated as an asset and vice versa, e.g. Repairs to building $400 was debited to the Building Account.
Complete Reversal of Entries: An account that should be debited is credited and vice versa, e.g. A cheque $200 received from Cyril was debited to the account of Cyril and credited to the Bank Account.
Compensating Errors: Errors (or error) on one side of the ledger are compensated by an error (or errors), e.g. The Purchases Account and Sales Account were both overcast by $150.
Errors of Original Entry: The original figure may be incorrectly entered although the correct double-entry principle has been observed using this incorrect figure, e.g. Credit sales of $87 to Kay was recorded in the Sales Account and Kay's account as $78.
Errors which are revealed by the Trial Balance are those errors which cause the Trial Balance totals to be in disagreement.
Errors in Calculation: If there is any miscalculation of the Trial Balance totals or the net account balances, the Trial Balance will not balance, e.g. There was an error in the calculation of the cash balance, causing the Trial Balance totals not to balance too.
Errors in Omission of One Entry: Omission of either the debit or credit entry of a transaction will cause the totals of the Trial Balance not to agree, e.g. A cheque $500 received for commission was debited to the Bank Account only.
Posting to the Wrong Side of An Account: Entry into the wrong side of an account will cause one side of the ledger to be more than the other, e.g. A cheque of $800 paid to creditor, K. Wang was credited instead of debited to his account.
Errors in Amount: If the debit entry of a transaction differs in amount with the credit entry, the Trial Balance will not balance, e.g. Cash $134 received from Caine was debited to the Cash Account as $134 and credited to the account of Caine as $143.
An account has a debit balance when its debit total exceeds its credit total.
An account has a credit balance when its credit total exceeds its debit total.
Asset, expenses and drawings accounts have debit balances.
Liability, capital and revenue accounts have credit balances.
A Trial Balance is a list of debit and credit balances extracted from the accounts in the ledger at a particular date.
The Trial Balance is prepared for the purpose of checking the arithmetical accuracy of the entries made in the ledger.
The total debit balances will equal the total credit balances in the Trial Balance if the double-entry principles of recording have been strictly adhered to.
Errors that effect the agreement of the Trial Balance totals are wrong calculation of balances, omission of either a debit or credit entry of a transaction, entry on the wrong side of an account, and errors in amount.
Errors that do not affect the agreement of the Trial Balance totals are complete omission of entries of a transaction, errors of commission, errors in principle, compensating errors, and errors in original entry.
Asset and liability accounts are balanced and their balances brought down to the next accounting period.
Personal accounts record transactions with persons who have dealings with the business, e.g. debtors and creditors accounts.