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Notes 05 - As - Trial Balance

A trial balance is a statement that lists all ledger account balances to ensure that total debits equal total credits, confirming the arithmetic accuracy of the books. It plays a crucial role in the accounting cycle by helping identify errors and providing a summary for financial reporting. However, it has limitations as certain errors may still go undetected even if the trial balance agrees.

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20 views4 pages

Notes 05 - As - Trial Balance

A trial balance is a statement that lists all ledger account balances to ensure that total debits equal total credits, confirming the arithmetic accuracy of the books. It plays a crucial role in the accounting cycle by helping identify errors and providing a summary for financial reporting. However, it has limitations as certain errors may still go undetected even if the trial balance agrees.

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nashra.rehan
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Trial Balance — Chapter 6 (Accounting)

A trial balance is a statement that lists all the balances from the ledger accounts at a
specific date. The balances are divided into two columns: one for debit balances and
the other for credit balances. The fundamental idea behind preparing a trial balance
is to check whether the total value of debit entries equals the total value of credit
entries, as required by the double-entry bookkeeping system. According to this
principle, for every transaction, the amount debited must be equal to the amount
credited. Therefore, when a trial balance “agrees”, it indicates that the arithmetic in
the books is likely accurate.

However, agreeing totals do not mean there are no mistakes at all—just that certain
kinds of errors (discussed later) are not present. The trial balance helps in identifying
mistakes that affect the balance between debits and credits and also acts as a base for
preparing final accounts.

Purpose and Use of the Trial Balance


The trial balance plays a key role in the accounting cycle. It serves to confirm the
mathematical correctness of the ledger entries and helps in identifying common
errors. Moreover, it provides a summary of all balances in one place, making it easier
to prepare financial reports such as the income statement and the balance sheet.

Most businesses prepare a trial balance at least once a year, especially before
creating financial statements. Larger companies may prepare it monthly or quarterly
to generate timely reports for management. Today, many businesses use
computerized accounting systems, which allow a trial balance to be generated
instantly and accurately at any time.

Steps in Preparing a Trial Balance


To prepare a trial balance manually, follow these steps:

1. First, balance all the individual ledger accounts, including the cash book.
2. Next, list down the balances in two columns: those with debit balances go in
the debit column and those with credit balances go in the credit column.
3. Then, sum up each column. If both totals are equal, the trial balance is said to
"agree".
4. Any account with no balance (meaning the debit and credit entries are equal)
is not included in the trial balance.

For example, if the total of the debit side is $120,000 and the credit side also adds up
to $120,000, it confirms that the books are arithmetically correct up to this stage.

What to Do If the Trial Balance Fails to Agree


When the totals do not match, this indicates that an error has occurred during
recording or posting. Before diving deep, it is a good idea to perform a few simple
checks:

 Check the addition of both columns.


 Make sure all account balances have been included and placed in the correct
column.
 If the difference is divisible by 2, it could mean an amount has been recorded
on the wrong side.
 If the difference is divisible by 9, it might be a transposition error (e.g.
writing 69 instead of 96).
 If nothing is found, return to the individual ledgers and verify balances and
postings again.

Limitations of the Trial Balance


A major limitation is that even if the trial balance totals agree, certain types of errors
may still exist. This is because the trial balance only confirms that every debit has a
corresponding credit. It does not check whether the correct account was debited or
credited, or whether the correct amount was entered.

Types of Errors Not Revealed by the Trial Balance


(with Examples)
Some errors go undetected because they do not affect the equality of debits and
credits. These include:

1. Error of Omission

This occurs when a transaction is completely left out of the records. Since both the
debit and credit are missing, the trial balance still agrees.

Example: You bought equipment for $500 in cash but forgot to enter the transaction.
There’s no debit to Equipment and no credit to Cash.

2. Error of Commission

Here, the transaction is posted to the correct type of account but the wrong specific
account within that class.

Example: You paid a telephone bill but posted it to the lighting expense account.
Both are expenses, so the trial balance still balances even though the entry is
incorrect.

3. Error of Original Entry


This is when the wrong amount is recorded from the beginning in the book of prime
entry.

Example: A sales invoice of $250 is mistakenly recorded as $25 in the sales journal.
This mistake is then carried into the ledgers, but since both debit and credit are
equally wrong, the trial balance agrees.

4. Complete Reversal of Entries

The transaction is posted with the correct amount but to the wrong sides of the
accounts.

Example: A payment received from Ali is debited to Ali’s account and credited to the
bank. It should be the other way round.

5. Error of Principle

This error occurs when a transaction is posted to the wrong type of account.

Example: Petrol expense for a car is debited to the Motor Vehicles (asset) account
instead of the Vehicle Expenses (expense) account. Although debits and credits are
matched, the classification is wrong.

6. Compensating Errors

In this case, two or more unrelated errors cancel each other out, so the trial balance
still agrees.

Example: The sales account is understated by $200, and a customer’s account is


also understated by $200. The net effect is zero on the trial balance.

Example Problems
Problem 1:
The bank was credited with $1,000 received from a customer, but the customer’s
account was also credited.
→ This is a complete reversal of entries.

Problem 2:
A purchase of $850 was entered as $580 in both the purchases account and the
supplier’s account.
→ This is an error of original entry.

Problem 3:
Payment of rent was posted to salaries.
→ This is an error of commission.
Problem 4:
$2,000 worth of equipment was bought but not recorded at all.
→ This is an error of omission.

Conclusion
The trial balance is a vital step in the accounting process. It verifies that every debit
has a corresponding credit and provides a foundation for preparing final accounts.
However, it's important to remember that while a trial balance helps identify certain
errors, it cannot detect all mistakes—especially those involving the wrong accounts,
missing entries, or incorrect amounts.

Therefore, attention to detail is a crucial skill for any bookkeeper or accountant. Being
organized, careful with numbers, and familiar with the common types of errors can
help ensure that financial statements are accurate and reliable. The trial balance,
though not perfect, remains a key tool in catching mistakes early and keeping the
accounting process on track.

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