Every business needs financial statements. It forms the core of a business and reflects major balances pertaining to its finances at a certain point. A trial balance is one of the ways to interpret a company’s financial position.
In Singapore, most customers are accustomed to preparing a range of financial statements, including a balance sheet.
This article discusses trial balance, reasons for preparing it, and its advantages and disadvantages.
What is a trial balance?
A trial balance is a report that summarizes the balances of all general ledger accounts of a company at the end of an accounting period. It is a part of the double-entry bookkeeping and presents ledger accounts either as a debit or a credit balance. Here, each debit entry has a corresponding credit entry.
In trial balance, the debit balance represents assets, losses and expenses whereas the credit balance represents equity, liabilities, revenues and gains. It is prepared as on a date, usually at the end of every quarter and year.
The purpose of preparing a trial balance is to showcase that the total of all debits equals the total of all credits and the company’s bookkeeping system is mathematically accurate.
What is the difference between a trial balance and a general ledger?
A trial balance forms the core and comes right after posting journal entries to the requisite ledgers and just before you prepare the financial statements.
However, a general ledger summarises all transactions occurring of a company and the ending balance in each general ledger account will be presented in the trial balance.
Also, read our article on “Trial balance vs balance sheet”.
Why prepare a trial balance?
Here is why companies prepare a trial balance –
Establishing the accuracy of closing ledger balances
The primary reason for preparing a trial balance is to jot down the closing balances of all the ledger balances. It helps in ascertaining the accuracy of journal and ledger postings. It is assumed to be accurate when its debit balance matches its credit.
Aids in financial statement preparation
A trial balance acts as the bridge between your company’s accounting records and financial statements. It is made in accordance with the double-entry bookkeeping and ensures that all the entries in the general ledger are appropriately balanced and accounted for.
A trial balance presents the closing balance of all the general ledger balances on a particular date. It allows auditors to compare them with any previous period to ascertain audit areas that require more focus for the current period.
Here are the advantages of preparing a trial balance –
Presents a bird’s-eye view
If the onlookers want to get a quick view of the company’s financial position on a particular date, they can go through the balances in the trial balance.
The basis of double-entry bookkeeping is that every credit will have an equal and opposite debit. Therefore, with a trial balance listing all the accounts as on a particular date, it is imperative that the total credit balance must match the debit total.
Makes posting adjustments easier
When you have a balanced trial balance prepared, it becomes convenient for you to make post-trial balance adjustments to present the company’s financial statements.
How to prepare a trial balance?
A trial balance is a summary statement and comprises all the ending balances from each general ledger account. You won’t find details of individual transactions, but only the balance as on a date.
Most companies follow the T-format of the trial balance.
Here are the steps to prepare a trial balance –
Collate the balances of all the general ledger accounts
The first step is to gather all the ledger balances as on the date the trial balance is to be prepared. It is imperative to understand that transactions are first recorded via journal entries which are then transferred to the respective ledgers. The balance of each ledger is then ascertained for the day for which the trial balance is to be prepared.
Post debit or credit balance in the trial balance
The next step is to post them on the debit or credit side according to their closing balances. Usually, incomes and liabilities ledgers have a credit balance, whereas expenses and assets have a debit balance.
Compute the balance of each side
Compute the total of the credit and debit sides separately. It is done after you have completed the process of recording all the balances of the respective side. Ideally, both balances should match.
Treatment for discrepancy
If you encounter a discrepancy, you will have to carry out additional procedures to find out the reason behind the same and rectify it. Even in cases where your debit and credit balances tally, it is not proof that your accounting records are error-free. It only means that you have posted the general ledger balances correctly.
Types of trial balance
You can come across two kinds of trial balance –
Unadjusted trial balance
As the name suggests, it is a trial balance without adjusting entries. It is an internal document that only helps verify if the general ledger debit and credit balances tally in the preliminary stages of drafting financial statements.
Adjusted trial balance
Adjusted trial balances are prepared when your financial statement preparation is at an advanced stage. It inculcates all the entries relevant for the day the trial balance is to be prepared, but the intimations were received after that date. Thus, it helps in making the trial balance more relevant for the preparation of financial statements.
Limitations of trial balance
There are some reasons why a trial balance is not considered appropriate to ascertain the financial position of a company –
Unable to trace on missing transactions
If you miss out on recording complete transactions (both debit and credit sides), the trial balance will still tally and is incapable of informing you of the same.
Incapable of highlighting offsetting errors
There are times when the accountant enters multiple incorrect entries, but the overall impact on the accounts is nil as they offset each other. We cannot detect such instances by preparing a trial balance.
Cannot report duplicate posting or reverse posting
You paid annual rent once but somehow recorded it twice in your books. You can also enter a debit balance as credit and vice versa. A trial balance cannot detect them, and the balances will still tally.
Errors not revealed in the trial balance
One of the significant limitations of a trial balance is its incapability of reporting certain error types. It includes errors of omission, commission, and more.
Click here to read a detailed article on “Errors not revealed in the trial balance.”
Given the limited usage of trial balance in present-day accounting, most companies have parted ways with it. However, it has not entirely become redundant, and several companies with hundreds of ledger accounts tend to use it as a safety buffer. It includes banks and lending agencies, amongst others.
Intime Accounting offers hassle-free trial balance preparation and other outsourced accounting services. Contact us for professional advice.