The trial balance (AS Level) Financial accounting

 

The trial balance

Definition and Purpose of the Trial Balance

A trial balance is fundamentally a list of the balances on each account extracted from the ledgers at a particular date.

The central purpose of preparing a trial balance is to verify the accuracy of the double-entry bookkeeping system:

1. Arithmetical Check: Its main function is to check that the total of the debit balances equals the total of the credit balances.
2. Confirmation of Duality: The agreement of these two totals confirms that for every transaction recorded, an equal and opposite credit entry has been made in another account, which confirms the accuracy of the bookkeeping to a great extent.
3. Precursor to Financial Statements: The trial balance is an essential step that must be completed and balanced before the preparation of financial statements takes place. It provides the source data required for preparing the Income Statement and the Statement of Financial Position (with the exception of closing inventory).

The frequency with which a trial balance is prepared varies depending on the business:

• Sole Trader: Usually prepared once a year at the year-end.
• Large Company: Typically prepared every month to facilitate the preparation of monthly management accounts.
• Computerized Systems: Can be prepared at any time.

 How to Prepare a Trial Balance

The process of preparing a trial balance is systematic:

1. Balance Accounts: First, all ledger accounts (including the cash book) must be balanced.
2. List Balances: Next, list all the accounts, separating the resulting debit balances and credit balances into designated columns.
3. Total and Compare: The total of the debit balances should equal the total of the credit balances. If they are equal, the trial balance agrees.

When accounts that have been divided into specialized ledgers (like the Sales Ledger and Purchase Ledger) are included, the process consolidates the individual balances:

• The balances from the Sales Ledger are listed and totalled, and the total is entered in the trial balance as Trade Receivables (a debit balance).
• The balances from the Purchase Ledger are listed and totalled, and the total is entered as Trade Payables (a credit balance).

Limitations of the Trial Balance

A critical concept is that even if a trial balance agrees (balances), it does not guarantee that there are no errors in the bookkeeping. It only proves that the fundamental rule of double-entry (equal debits and credits) has been maintained.

There are six types of error which do not affect the agreement of the trial balance:

Type of Error	Explanation
Errors of Omission	A transaction is omitted completely from the books, resulting in neither a debit nor a credit entry being made.
Errors of Commission	A transaction is posted to the wrong account, but the account belongs to the same class (e.g., posting a telephone bill payment to the heating and lighting expense account).
Errors of Principle	A transaction is posted to the wrong class of account (e.g., recording the purchase of a motor vehicle, which is a capital expenditure, in the motor expenses account, which is revenue expenditure).
Errors of Original Entry	The wrong amount is entered initially, but the double entry is completed using that wrong amount (e.g., an invoice for $100 is entered as $1,000 in both accounts).
Complete Reversal of Entries	The correct accounts are used, but the debit and credit entries are reversed (e.g., debiting the account that should have been credited, and vice versa).
Compensating Errors	Two or more separate, unrelated errors cancel each other out, causing the totals to agree artificially.

These errors can still lead to financial statements showing incorrect figures (e.g., an error of principle, like recording a motor vehicle purchase as an expense, will understate the profit for the year).

What to Do if the Trial Balance Fails to Agree

If the total of the debit balances and credit balances do not agree, there must be a mistake in the bookkeeping. Before spending time checking every individual posting, certain simple checks should be performed:

1. Check Additions: Verify the mathematical summation of the trial balance columns.
2. Check for Division by Two: If the difference is exactly divisible by 2, look for an account balance equal to half the difference, which may have been placed on the wrong side of the trial balance (e.g., a $542 debit placed in the credit column would cause a total difference of $1,084).
3. Check for Transposition: If the difference is divisible by 9, look for a balance where digits may have been reversed (e.g., $542 entered as $524).
4. Check Extraction: Verify the extraction of balances from the ledgers.
5. Check Control Accounts: If control accounts (like the Sales Ledger Control Account) have been prepared, compare their balances with the totals of the balances extracted from the respective individual ledgers.

If the cause of the difference cannot immediately be found, and the financial statements are needed urgently, a suspense account may be opened to record the difference and allow the accounts to be balanced temporarily.