3.1.1 The source and structure of trial balance
A trial balance is a list with two columns, which are debit and credit. It is important to every company that they need to check the errors that maybe made during enter the transactions into general accounts. If the principles of the double entry have been correctly applied to the recording of transactions in ledger accounts, the total of debit balances will equal to the total of credit balances. So the total of the debit column should be equal to the total of credit column in the trial balance. The functions of trial balance are first to detect errors made in the recording of transactions by comparing the totals of debit and credit columns. And second is to be a basis for preparation of the financial statements at the end of accounting period.
How the steps go?
After finish entering all the transactions to all the general accounts, it is time to start preparing a trial balance to detect the errors and get prepared to make financial statements.
Step 1 – Extract the closing balances of ledger accounts
In every general ledger account, there always will have a balance figure that is going to be brought down to next month then we can take the figure to the trial balance. To all the debits in the account, we should find the left side of the account. To all the credits in the account, we should find the total of the right side of the account. If the debit and credit sides of an account are equal, the account has a zero balance. Example:
The closing balance of cash account in 2012 is 743,000, which is the figure color in red. So, first we need to extract this figure, which is called the closing balance, to the trial balance. Also, since the closing balance is a debit balance, so we are going to post the figure in the debit column, which is the left side of the trial balance.
Step 2 – Recording the balances with their account titles
This step is to record and list all the debit balances into debit column and all the credit balances into the credit column in the trial balance and with their account titles. Example:
After spotting out the closing balance of cash account, we are going to post the number on the debit column as the above figure shows and also with the account title, which is called ‘cash’.
Step 3 – Add up the debit balances and credit balances separately Example:
As the above figure shows that all the balances of debit side and credit side are added up separately, and the totals should be in same figure.
Step 4 – Comparing the totals
If the double entries in the ledger accounts are of equal amounts, the totals of debit and credit balances extracted from ledger accounts will equal and the trial balance is said to agree. Conversely, if the totals are in different figures, the trial balance is said to disagree.
3.1.2 Limitations of a trial balance
Error of commission
This is an error is where an entry has been made in a wrong account but with a correct amount, it will not affect the agreement of the trial balance though. For example, a trade debtor Mr. X paid us $500 by cheque, and the entry was incorrectly made as follow:
Dr Bank account $500
Cr MR. Y $500
The receipt was wrongly credited to Mr. Y account instead of Mr. X account. The figure of $500 that credited to accounts receivable ledger will be then recorded in the credit column in the trial balance. From this result, the wrong account but with the correct figure will not affect the trial balance agreement.
Error of principle
This is an error that refer to an entry has been made in the wrong type of account but will not affect the agreement of the trial balance. For example, we purchased machinery for $55,000 by cheque, and the double entry was wrongly recorded as follow:
Dr Machinery expense account $ 55,000
Cr Bank account $ 55,000
But the correct entry is as follow:
Dr Machinery account $ 55,000
Cr Bank account $ 55,000