Accounting in an organization plays a vital role, with its help a business can manage all its financial records. The trial balance is the key point in accounting, which helps the company ensure transaction accuracy. Using a trial balance in accounting makes your financial records error-free.
In this blog, we have briefly discussed what a trial balance in accounting is, its key components, the types of trial reports and the purpose of a trial balance in accounting.
What is a Trial Balance in Accounting?
In accounting, a trial balance makes sure that both debits and credits are balanced in the accounting system. It is mainly a report that explains the balance of all the ledger accounts of a company at a certain point in time. A trial balance is used to calculate whether the sum of debits is equal to the sum of credits. A trial balance in accounting includes all the essential accounting items, such as assets, liabilities, etc. A trial balance is used to check the balance of debit and credit entries from the transactions recorded in the general ledger.
Trial Balance Example
Here is a trial balance example given below:
For example, an organization has written 5000 accounts receivable in debit and in credit zero, and written 5000 in accounts payable in credit and in debit zero. In this trial balance example the total debits and credits both equal 5000, which means the books are balanced. If the totals didn’t match then you have to find and fix the mistake before preparing further financial statements.
What are the Key Components of a Trial Balance in Accounting?
There are the key components of a trial balance in accounting are given in brief:
Debits and Credits
- Debits in a trial balance are always recorded on the left side. Debits typically include the assets, expenses and withdrawals.
- Credits in a trial balance are always recorded on the right side. Credits typically include the liabilities, equity and revenue.
Accounts
- Assets are included in the accounting part of a trial balance. For example, cash, accounts receivable, etc.
- Liabilities are included in the trial balance in accounting. For example, accounts payable, loans, etc.
- Equity of a company is included. For example, common stock, retained earnings, etc.
- Revenue is included in a trial balance in accounting. For example, sales, service, income, etc.
- Expenses are also included in the trial balance in accounting. Example, rent, utilities, etc.
Purpose
The main purpose of a trial balance is to ensure that the debits and credits are equal after posting all the transactions which helps you to identify errors in the ledger entries easily.
Steps for Preparing a Trial Balance
- Post all the transactions to the general ledger.
- For each account calculate the balances.
- List all the account names and their balances in the trial balance.
- Errors detected by the trial balance.
- If the trial balance does not balance that indicates that there might be an issue in the accounting system. Common issues are incorrectly balancing accounts, missing entries, and misposting amounts.
Types of Trial Balance Report
There are three types of balance report given below:
- Unadjusted Trial Balance: It is prepared before any adjusting entries are made.
- Adjusted Trial Balance: An adjusted trial balance is prepared after all the adjustments are made. It ensures that your financial statements show accurate figures.
- Post-closing Trial Balance: It is prepared after closing entries have been made, showing balances for permanent accounts only.
What is the Purpose of a Trial Balance in Accounting?
- Error Detection: A trial balance helps with the mathematical errors in the bookkeeping process. If you see sum of the debit column does not equal the total of the credit column, it indicates that an error has occurred that needs to be corrected.
- Foundation for Financial Statements: For the preparation of the formal financial statements, the trial balance provides the necessary data. For example income statement and the balance sheet.
- Internal Control: A trial balance is an internal report that is used by the accountant and the management to conclude the financial health of an organization and ensure the accuracy of the books.
- Ensures Transaction Accuracy: A trial balance report makes sure that each and every transaction has been recorded accurately without any mistakes according to the double-entry system.
- Supports Audits and Tax Preparation: The trial balance can be used by auditors to identify which accounts to review and is a useful document for tax preparation.
Limitations of Using a Trial Balance Format
- Doesn’t Catch All Errors: The trial balance may fail to detect errors when an incorrect amount is contained in the journal entry, which is recorded in both accounts. It does not guarantee flawless books either.
- Challenges in Manual Preparation: If not using accounting software and preparing a trial balance manually, then it can be challenging and time-consuming.
- Limited Fraud Detection: A trial balance just checks the math but not the rightfulness of the transactions which makes it limited in fraud detection.
- Missing Entry: Any missing journal entry in the ledger will not be reflected in the trial balance which makes it challenging to spot such omissions.
Conclusion
A trial balance is the first step in checking an organization’s finances as it helps accountants to be sure that no mathematical error has occurred before proceeding with other complex financial statements. A business should use a trial balance as it can help the business by detecting some types of errors which helps an organization to save its time.