Before learning how to read a trial balance, it is essential to understand what trial balance is, why it is important in the accounting cycle, and how to prepare it.
In very simple terms, you will discover all of these and more by reading this post. So, let’s get started.
What Is A Trial Balance?
A trial balance is a list of balances extracted from the ledger accounts at a given date, arranged according to whether they are debit balances or credit balances. The ledger accounts prepared by the entity are accurate if both credit and debit balances on the trial balance agree. This means the double-entry principle has not been violated by the organization.
The trial balance is the key link between posting entries in the ledger and the preparation of financial statements. While the trial balance itself is neither a ledger account nor a financial statement. However, it contains all the relevant information needed for the preparation of financial statements.
What Are The Uses Of Trial Balance?
A majority of people have a misconception about when trial balances can be prepared. The usual practice is for businesses to prepare trial balances at the end of an accounting period just before preparing the financial statements. Nonetheless, trial balances can be prepared at any time whatsoever.
The uses of trial balances are:
- To ascertain the accuracy of balances obtained in the ledger accounts. This is determined by checking if the left and right sides of the trial balance equal the same amount.
- To detect errors that can be easily detected by the trial balance.
- The preparation of the financial statement would be paused until the errors affecting trial balances are correct. Thereby helping in the preparation of a fair and true financial statement.
- It provides a summary of an entity’s accounting transactions.
- It is a working paper used for accountants when preparing financial statements.
- During the external audit of a company’s financial statement, trial balances help the auditors in determining whether the F.S are true and fair, and so on.
It is important to understand there are two types of errors in the trial balance.
Errors Affecting Trial Balance
These errors are those that cause the trial balance not to balance. Examples of these errors are:
- Posting the wrong balance from the ledger a/c to the trial balance
- Arithmetical errors in the ledger a/c
- Posting different figures for the credit and debit side in a trial balance for the same transaction i.e. overstatement and understatement of figures.
- To identify a credit balance as debit balance in the trial land vice versa.
Errors Not Affecting Trial Balance:
These are errors that cannot be detected by the trial balance. They are:
- Where both the debit and credit entries for a transaction are omitted from the trial balance.
- Where the error arose from source documents like cash receipts, trade invoices.
- Where a debit entry is posted as credit entry for a transaction and the credit entry is posted as debit.
Immediately you identify an error affecting trial balance. This is what you’ll do:
Record the difference between the credit and debit balance in a suspense account until the error is corrected.
How To Read A Trial Balance
Follow these steps to correctly read a trial balance:
- Get hold of the ledger accounts and confirm the entry posted in the trial balance against the titles of the available ledger accounts.
- Pay careful attention to the titles of ledger account balances in the trial balance and ensure correct balances in the ledger are posted in the trial balance.
- Trace back the ledger a/cs listed in the trial balance to ensure no ledger entry is omitted.
Please note that the 5 elements of accounting i.e. Assets, Liabilities, Revenue, Equity, and Expenses are summarized in the trial balance. The net balances of assets and expenses account will always be on the left side of the trial balance while those of equity, revenue, and liabilities will be on the right side.
What Are Its Limitations?
- Trial balance does not reveal all types of errors. For instance where a transaction is completely omitted from the trial balance.
- Trial balance cannot detect errors arising from source documents. For instance, where a cash receipt of $100,000 was wrongly recorded and understated as $10,000 on the receipt. It will require a detailed investigation to find out this type of error just glancing at the trial balance will not reveal it.
Just before we begin the concluding part of this article:
Let me take the chance to exemplify the different types of trial balances for your sake. There are two types of trial balance and they are;
- Adjusted trial balance
- Unadjusted trial balance.
Adjusted trial balance usually includes adjustments for prepaid and accrued expenses along with notional expenses like depreciation. Once these adjustments have been included in the trial balance, the accountant can proceed with the preparation of the financial statement.
On the other hand:
Unadjusted trial balance refers to the trial balance that hasn’t been subjected to any form of adjustment. They are the balances lifted directly from an entity’s ledger account.
Differences Between Statment of Financial Position And Trial Balance
- Statement of financial position is part of the final accounts prepared at the end of any accounting year while a trial balance is just a working paper.
- Statement of financial position is prepared at the end of an accounting year while the trial balance can be prepared at any time.
- A trial balance summarizes all five accounting elements under the debit and credit entry. The SOFP on the other hand shows the balance of the Assets, Liabilities, and Equity.
- The statement of financial position is usually vetted by an external auditor to verify its fairness and accuracy while a trial balance is not.
- The ledger account is the basis for trial balance while the trial balance is the basis for SOFP.
- Trial balance features all classes of accounts from real (e.g bank a/c), personal (account receivable a/c), and nominal(expenses, revenue a/c) account balances while SOFP features just the real and personal accounts.
These are some of the key differences between the statement of financial position (SOFP) and trial balances. Nonetheless, none of these makes neither the trial balance nor the SOFP less important. Both are key to a successful accounting cycle anytime any day.
Just before you go:
See this video example by James from Accounting Stuff to further aid you in learning how to read a trial balance.