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
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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.
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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.
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Trial balance ensures that the account balances are accurately
extracted from accounting ledgers.
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Trail balance assists in the identification and rectification of
errors.
Example
Following
is an example of what a simple Trial Balance looks like:
1.
Title provided at the top shows the name of the entity and
accounting period end for which the trial balance has been prepared.
2.
Account Title shows the name of the accounting ledgers from which
the balances have been extracted.
3.
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).
4.
The sum of all debit and credit balances are shown at the bottom
of their respective columns.
Limitations of a trial
balance
Trial
Balance only confirms that the total of all debit balances match the total of
all credit balances. Trial balance totals may agree in spite of errors. An
example would be an incorrect debit entry being offset by an equal credit
entry. Likewise, a trial balance gives no proof that certain transactions have
not been recorded at all because in such case, both debit and credit sides of a
transaction would be omitted causing the trial balance totals to still agree.
Types of accounting errors and their effect on trial balance are more fully
discussed in the section on Suspense Accounts.
How to prepare a Trial Balance
Following Steps are involved in
the preparation of a Trial Balance:
1.
All Ledger Accounts
are closed at the end of an accounting period.
2.
Ledger balances are
posted into the trial balance.
3.
Trial Balance is cast
and errors are identified.
4.
Suspense account is
created to agree the trial balance totals temporarily until corrections are
accounted for.
5.
Errors identified
earlier are rectified by posting corrective entries.
6.
Any adjustments
required at the period end not previously accounted for are incorporated into
the trial balance.
Closing Ledger Accounts
Ledger accounts are closed at the
end of each accounting period by calculating the totals of debit and credit
sides of a ledger. The difference between the sum of debits and credits is
known as the closing balance. This is the amount which is posted in the trial
balance.
How closing balances are presented
in the ledger depends on whether the account is related to income statement
(income and expenses) or balance sheet (assets, liabilities and equity).
Balance sheet ledger accounts are closed by writing 'Balance c/d' next to the
balancing figure since these are to be rolled forward in the next accounting
period. Income statement ledger accounts on the other hand are closed by
writing 'Income Statement' next to the residual amount because it is being
transferred to the income statement as revenue or expense incurred for the
period.
The steps involved in closing a
ledger account may be summarized as below:
1.
Add the totals of both
sides of a ledger
2.
The higher of the
totals among the debit side and credit side must be inserted at the end of BOTH
sides.Closing balance is the balancing figure on the side with the lower
balance.
3.
In case of ledger
accounts of assets, liabilities and equity, 'balance c/d' is written next to
the closing balance whereas in case of income and expenses ledger accounts,
'Income Statement' is written next to the closing balance.
4.
The closing balances
of all ledger accounts are posted into the trial balance.
Next sections contain examples
illustrating how the various types of ledger accounts are closed at the period
end 31 December 2011