What is a Trial Balance? | Objectives and Rules
A trial balance is a bookkeeping or accounting report that lists the balances in each of an organization’s general ledger accounts.
Whenever a trial balance is prepared, its total on the debit side should tally with the total on the credit side. An agreement of both sides indicates a reasonable (but not conclusive) accuracy of accounting work. If two sides do not tally, there is undoubtedly some error.
It emerges from the principle of the Double Entry System that the amounts written on the debit side are always equal to the credit side. Once an agreement is established, it is an indication that the accounting work is free from clerical errors.
However, this accuracy is only reasonable accuracy. It cannot be said absolute accuracy because some errors of principle and compensating errors do not result in disagreement of trial balance, and a layman will think that accounts have been accurately prepared.
Generally, the trial balanceĀ is prepared monthly or quarterly, depending on the organisation’s size.
Objectives of Preparing Trial Balance
1. To Verify Arithmetical Accuracy: The most fundamental objective of a trial balance is to ensure that the recording of your financial transactions in the ledgers is mathematically accurate. The trial balance helps identify any errors in addition, subtraction, or posting that might have occurred during data entry. If the total debit balances don’t equal the total credit balances, you know there’s an error somewhere.
2. To Detect Errors and Discrepancies: By preparing a trial balance, you can potentially locate various kinds of errors in your accounting records. These could include transposition errors (e.g., switching digits), omission of entries, or double counting of transactions. Identifying these errors early on prevents them from snowballing into bigger issues in your financial statements.
3. To Serve as a Starting Point for Financial Statements: The trial balance serves as a crucial stepping stone for creating financial statements like the balance sheet and income statement. It summarizes the final balances of all the accounts in your ledger, which becomes the starting point for preparing these statements.
4. To Facilitate Internal Control and Auditability: Preparing a trial balance regularly fosters internal control by providing a mechanism for internal checks and balances. Additionally, it simplifies the auditing process by presenting a consolidated overview of all accounts, making it easier for auditors to track and verify financial data.
5. To Aid in Decision-Making: By providing a summarized picture of your financial position, the trial balance can inform various business decisions. You can use it to assess your overall financial health, identify areas for improvement in terms of income and expenses, and track progress towards financial goals.
Limitations of Trial Balance
One should note that the agreement of Trial Balance is not conclusive proof of accuracy. In other words, despite the agreement on the trial balance, some errors may be undetected. These may be of the following types:
(i) The transaction has not been challenged at all in the journal.
(ii) The wrong amount has been written in both journal columns.
(iii) A wrong account has been recorded in the journal.
(iv) An entry has not at all been posted to the ledger.
(v) Entry is posted twice in the ledger.
Still, the preparation of the trial balance is advantageous. Without it, preparing the financial statement, the profit and loss account and the balance sheet would be very difficult.
Trial Balance Format
Rules for the Preparation of Trial Balance
While preparing the trial balance from the given list of ledger balances, the following rules should be taken into care:
- The balances of all assets, expense accounts, losses, drawings, cash and bank balances are entered in the debit column of the trial balance.
- The balances of all liability accounts, income, profits, and capital are entered in the credit column of the Trial Balance.
- If for some reason, both sides do not tally, the difference should be transferred to the suspense account temporarily. Still, the suspense account should be reconciled for reasons of difference before preparing the final accounts. Having a suspense account is not a good practice.
Conclusion
In short, preparing a trial balance is a crucial step in maintaining accurate and reliable accounting records. It helps ensure data integrity, detect errors, and provides a foundation for financial statement preparation and informed decision-making.