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TOPIC 4: TRIAL BALANCE
Trial Balance
You learn about general journals and general ledger on the first topic. In this topic we're going to explore the next process of an accounting cycle which is trial balance. You are going to explore what it is and understand how to prepare it.Lets remind ourselves of an accounting cycle before we start to explore about trial balance.
Meaning of Trial Balance
Define the Trial Balance
Trial Balance is a list of closing balances of ledger accounts on a certain date and is the first step towards the preparation of financial statements. It is usually prepared at the end of an accounting period to assist in the drafting of financial statements. Ledger balances are segregated into debit balances and credit balances. Asset and expense accounts appear on the debit side of the trial balance whereas liabilities, capital and income accounts appear on the credit side. If all accounting entries are recorded correctly and all the ledger balances are accurately extracted, the total of all debit balances appearing in the trial balance must equal to the sum of all credit balances.
Purpose of a Trial Balance
- Trial Balance acts as the first step in the preparation of financial statements. It is a working paper that accountants use as a basis while preparing financial statements.
- Trial balance ensures that for every debit entry recorded, a corresponding credit entry has been recorded in the books in accordance with the double entry concept of accounting. If the totals of the trial balance do not agree, the differences may be investigated and resolved before financial statements are prepared. Rectifying basic accounting errors can be a much lengthy task after the financial statements have been prepared because of the changes that would be required to correct the financial statements.
- Trial balance ensures that the account balances are accurately extracted from accounting ledgers.
- Trail balance assists in the identification and rectification of errors.
Construction of Trial Balance
Construct a Trial Balance
Example
Following is an example of what a simple Trial Balance looks like:
| ABC LTD Trial Balance as at 31 December 2011 | ||
| Account Title | Debit | Credit |
| $ | $ | |
| Share Capital | 15,000 | |
| Furniture & Fixture | 5,000 | |
| Building | 10,000 | |
| Creditor | 5,000 | |
| Debtors | 3,000 | |
| Cash | 2,000 | |
| Sales | 10,000 | |
| Cost of sales | 8,000 | |
| General and Administration Expense | 2,000 | |
| Total | 30,000 | 30,000 |
- Title provided at the top shows the name of the entity and accounting period end for which the trial balance has been prepared.
- Account Title shows the name of the accounting ledgers from which the balances have been extracted.
- Balances relating to assets and expenses are presented in the left column (debit side) whereas those relating to liabilities, income and equity are shown on the right column (credit side).
- The sum of all debit and credit balances is shown at the bottom of their respective columns.
The Advantages and Short Falls of the Trial Balance
Give the advantages and short falls of the Trial Balance
Advantages (Objectives of Trial Balance)
- 1. It ensures that the transactions recorded in the books of accounts have identical debit and credit amount.
- 2. Balance of each ledger account has been computed correctly.
- 3. Balance of each and every ledger account has been transferred accurately and on the correct side of the sheet on which trial balance has been prepared.
- 4. The debit and the credit columns of trial balance have been added up correctly.
- 5. Preparation of final accounts is not possible without preparing trial balance first.
- 6. Agreed trial balance is a prima facie evidence of the arithmetical accuracy of the accounting books maintained.
- 7. Errors which are revealed by preparing trial balance (listed below) are rectified even before the preparation of final accounts.
Errors revealed by (the preparation of) trial balance
- If trial balance does not agree, the disagreement may be due to :
- (1) Omission to post an amount into ledger: If an item is not posted from journal or subsidiary book to ledger, two sides of trial balance shall not agree, e.g., if goods sold on credit to A are recorded properly in sales book but not debited to A's account' in ledger, the debit side of trial balance shall fall short.
- (2) Omission to post an amount in trial balance: It is natural if balance 'of an account is not recorded in trial balance the two sides of trial balance shall not agree which is an indication of error in accounts.
- (3) Wrong totalling or balancing of ledger account: If any account in the ledger is wrongly totalled or balanced, then also the trial balance shall not agree.
- (4) Wrong totalling of subsidiary books: If the total of any subsidiary book is wrongly cast, it would cause a disagreement in the trial balance, e.g., if purchase book totaled Rs. 2,500 instead of 2,050, the debit side of the trial balance shall exceed the credit side by Rs. 450.
- (5) Posting on the wrong side: When an item is by mistake posted on the wrong side of the ledger account it would cause disagreement in the trial balance, e.g., if Rs. 200 have been allowed as discount and while posting into discount account the amount has been credited to discount account. It will result in a difference of Rs. 400 in two sides of trial balance.
- (6) Posting of wrong amount: If wrong amount is posted in one of the two accounts while posting, it would immediately cause disagreement of trial balance e.g. goods worth Rs. 690 have been sold to 'X' but 'X's account has been debited with Rs. 960. It will increase the debit side of trial balance by Rs. 270.
Trial Balance Limitations - Shortcomings of trial balance
- An agreed trial balance does not prove by itself that :
- 1. All transactions have been correctly analyzed and recorded in proper accounts. For example wages paid for installation of fixed asset might have wrongly been debited to wages account.
- 2. All the transactions have been recorded and nothing has been omitted.
- 3. Certain types of .errors (listed below) remain undetected even after the preparation - of trial balance.
Exercise 1
1. Why is it very important for a company to prepare a trial balance?2. What will happen to a company's financial statement if a trial balance will have a lot of errors?3. What is an accounting cycle?
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