What is Trial Balance?
A trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the ledger with a view to verify the arithmetical accuracy of posting into the ledger accounts.
To put it simply, A trial balance is a detailed list of all the nominal ledger (general ledger) accounts contained in the ledger of a business.
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Trial balance is an important statement in the accounting process as it shows the final position of all accounts and helps in preparing the final statements.
Objectives of Preparing the Trial Balance
Following are the objectives of preparing trial balance:
- To Check Arithmetical Accuracy
- To Help in Preparing Financial Statements
- Helps in Locating Errors
- Helps in Comparison
- Helps in Making Adjustments
To Check Arithmetical Accuracy
Arithmetical accuracy in ledger posting means writing the correct amount, in the correct account and on its correct side while posting transactions from various original books of accounts, such as Cash Book, Purchases Book, Sales Book, etc.
It also means not only the correct balance of the ledger account but also the totals of the special purpose Books.
To Help in Preparing Financial Statements
The ultimate objective of accounting is to prepare financial statements i.e. Trading and Profit and Loss Account, and Balance sheet of a business enterprise at the end of an accounting year. These statements contain balances of various ledger accounts.
As Trial Balance contains balances of all ledger accounts, in financial statements the balances of ledger accounts are carried from the Trial balance for proper analysis.
Helps in Locating Errors
If the total of two columns of the trial balance agree it is proof of arithmetical accuracy in the ledger posting. However, if the totals of the two columns do not tally it indicates that there are some mistakes in the ledger accounts. This prompts the accountant to find out the errors.
Helps in Comparison
Comparison of ledger account balances of one year with the corresponding balances with the previous year helps the management take some important decisions. This is possible by using the Trial Balances of the two years.
Helps in Making Adjustments
While making financial statements adjustments regarding closing stock, prepaid expenses, outstanding expenses etc are to be made. Trial balance helps in identifying the items requiring adjustments in preparing the financial statements.
Methods of Preparing Trial Balance
Followings are the methods of preparing trial balance:
Under this method, the total of each side in the ledger (debit and credit) is ascertained separately and shown in the trial balance in the respective columns. The total of a debit column of trial balance should agree with the total of credit column in the trial balance because the accounts are based on the double-entry system.
However, this method is not widely used in practice, as it does not help in assuming the accuracy of balances of various accounts and preparation of the financial statements.
This is the most widely used method in practice. Under this method, a trial balance is prepared by showing the balances of all ledger accounts and then totalling up the debit and credit columns of the trial balance to assure their correctness.
The account balances are used because the balance summarises the net effect of all transactions relating to an account and helps in preparing the financial statements. It may be noted that in the trial balance, normally in place of balances in individual accounts of the debtors, a figure of sundry debtors is shown, and in place of individual accounts of creditors, a figure of sundry creditors is shown.
This method is a combination of the totals method and balances method. Under this method, four columns for amount are prepared. Two columns for writing the debit and credit totals of various accounts and two columns for writing the debit and credit balances of these accounts.
However, this method is also not used in practice because it is time-consuming and hardly serves any additional or special purpose.
Classification of Errors in Trial Balance
Followings are the classification of errors in the trial balance:
Keeping in view the nature of errors, all the errors can be classified into the following four categories:
Errors of Commission
These are the errors that are committed due to wrong posting of transactions, wrong totalling or wrong balancing of the accounts, the wrong casting of the subsidiary books, or wrong recording of the amount in the books of original entry, etc.
For example, Raj Hans Traders paid Rs 25,000 to Preetpal Traders (a supplier of goods). This transaction was correctly recorded in the cashbook.
But while posting to the ledger, Preetpal’s account was debited with Rs 2,500 only. This constitutes an error of commission. Such an error by definition is of clerical nature and most of the errors of commission affect the trial balance.
Errors of Omission
The errors of omission may be committed at the time of recording the transaction in the books of original entry or while posting to the ledger. These can be of two types:
- Error of complete omission
- Eerror of partial omission
When a transaction is completely omitted from recording in the books of the original record, it is an error of complete omission.
For example, credit sales to Mohan Rs 10,000, not entered in the sales book. When the recording of the transaction is partly omitted from the books, it is an error of partial omission. If in the above example, credit sales had been duly recorded in the sales book but the posting from the sales book to Mohan’s account has not been made, it would be an error of partial omission.
Errors of Principle
Accounting entries are recorded as per the generally accepted accounting principles. If any of these principles are violated or ignored, errors resulting from such violations are known as errors of principle.
An error of principle may occur due to incorrect classification of expenditure or receipt between capital and revenue. This is very important because it will have an impact on financial statements. It may lead to under or overstating of income or assets or liabilities, etc
For example, the amount spent on additions to the buildings should be treated as capital expenditure and must be debited to the asset account. Instead, if this amount is debited to the maintenance and repairs account, it has been treated as a revenue expense.
This is an error of principle. Similarly, if a credit purchase of machinery is recorded in purchases book instead of journal proper or rent paid to the landlord is recorded in the cash book as payment to the landlord, these errors of principle. These errors do not affect the trial balance.
When two or more errors are committed in such a way that the net effect of these errors on the debits and credits of accounts is nil, such errors are called compensating errors. Such errors do not affect the tallying of the trial balance.
For example, if purchases book has been overcast by Rs 10,000 resulting in excess debit of Rs 10,000 in purchases account and sales returns book is undercast by Rs 10,000 resulting in short debit to sales returns account is a case of two errors compensating each other’s effect.
One plus is set off by the other minus, the net effect of these two errors is nil and so they do not affect the agreement of trial balance.
Limitations of a Trial Balance
Even though if we have a trial balance, which agrees on the debit and the credit column, it may not be able to disclose the following type of errors. Followings are the limitations of a trial balance:
- Errors of Principle
- Compensating Errors
- Error of Recording
- Error of Ommisssion
- Posting into Wrong Accounts
Errors of Principle
If an entry makes equal debit and credit into two concerned accounts, it will not mean any arithmetic error, because the amount on both sides is equal. But it is possible that the recording of the entry may be fundamentally wrong.
For example, the purchase of furniture is debited to the purchase account instead of the furniture account.
If one particular account is wrongly debited by say Rs 500 less, but at the same time another ledger is credited less by the same amount, then the errors will compensate each other and not shown in the trial balance.
Error of Recording
A Wrong Amount in the Books of Original Entry: As we know the ledger are prepared from the books of original entry. If the recording in the original entry is incorrect, it will not lead to the disagreement of trial balance and hence, the error will not be disclosed in the trial balance.
For example, a sale of Rs 640 was recorded as 604 in the sales book.
Error of Ommisssion
This means, if any financial transaction was completely forgotten and was not recorded in any of the books, then this error cannot be located in the trial balance. This is so because the entry is missing on both sides of the journal.
Posting into Wrong Accounts
For example, if cash paid to Mahesh was wrongly debited to Maheshwari’s account, it cannot be disclosed in the trial balance. This is so because the amount being credited is equal to the amount being debited. Hence, the trial balance will agree.