Understand a pivotal point in the accounting cycle through this tutorial on trial balance with a comprehensive trial balance example. Why is the trial balance so important? It’s important because it tells you if the general ledger’s debit and credit balances are in sync. If they are not, corrections and adjustments would have to be made before financial statements are prepared and the books are closed for the period.
What is a Trial Balance and where does it fit in?
The trial balance is a very important step within the accounting cycle. The entire process for the cycle begins when the books are open for the period and every business transaction (with a financial impact) that occurs is journalized and then posted to the general ledger. Towards the end of the period (a period can be a month, quarter or year for example), a worksheet is put together listing all the accounts in the ledger and their balances in order to verify the accuracy of the ledger. This is what is known as the trial balance. See diagram below for a look at the entire accounting cycle and where the trial balance fits in.
What is the purpose of a Trial Balance?
The purpose of a trial balance is to verify and ensure the accuracy of the general ledger. The ledger contains debit and credit balances from journal entries that are made throughout an accounting period. There are multiple steps involved to ensure the accuracy of the ledger and they will be discussed step by step. Note that just because you have equal debit and credit balances doesn’t mean the ledger is error free. That’s why it’s really important to make sure that every journal entry that occurs within the period is vetted for accuracy before it’s posted.
Mistakes do happen from time to time and it usually is reflected in the trial balance. Later in this tutorial, limitations of the trial balance will also be discussed with a couple of tactics you can use to discover any errors when the debit and credit balances don’t equal each other.
Step 1 – Trial Balance Example – Understand Debits, Credits, Normal Balances & Journal Entries
The first step in our trial balance example involves understanding what debit and credits are and the concept of normal balances. In double-entry accounting, every transaction has two sides to it in that it will affect at least one debit account and at least one credit account. A thorough discussion of credits and debits along with normal balances are discussed in this tutorial on Tabular Analysis (which is another way to ensure accuracy of the ledger). Read that first if you need to understand the aforementioned concepts.
Once you know the basics of journal entries and the general makeup of ledger accounts, it is very easy to understand why there is a need for a trial balance. If the reasons aren’t clear, know that the goal is preserve the integrity of vital information that will eventually play a part in the business decision making process. Since it’s never any business manager’s vision to see a business fail, the quality of factual information pertaining to the business must be pristine. The trial balance exercise is one way to accomplish that. Assuming you are comfortable with what has been said so far, proceed to the next step.
Step 2 – Trial Balance Example – Background Information
We need a business scenario, so let’s say for a moment that you are the owner of a consulting company that was recently started. As a business owner, you’ve witnessed several important business transactions take place throughout the prior month. You hired a bookkeeper from a temp agency to handle the books and he just handed you the financial statements for the period that just ended. The numbers in the financial statements look better than you expected and you’re happy about that. However, you are a little wary and want to make sure that the information in the financial statements are indeed accurate.
You keep a copy of the invoices and other important documents that you give your bookkeeper, so you begin there. In looking through your files, you make a list of everything that had a financial impact to the business – and here is the list you come up with:
|June 01||Made a deposit to a business bank account for the amount of $50,000.|
|June 03||Bought office supplies and equipment on account for $1,450|
|June 06||Billed a client $2,800 for services|
|June 11||Received payment for previous billing of $2,800 for services rendered.|
|June 14||Paid rent expenses of $1,400|
|June 15||Paid $3,604 in salaries|
|June 18||Paid $1,450 to vendor for the supplies and equipment bought on account|
|June 20||Billed a client $ 12,000 for consulting services|
|June 21||Paid $589 for travel, lodging and entertainment expenses.|
|June 24||Determined that the value of supplies you have left amounts to $997 (cost of supplies used was $453).|
|June 25||Withdrew $350 from the business account for personal use|
|June 27||Billed a client $19,500 for consulting services|
|June 30||Received $12,000 for June 20th billing|
|June 30||Paid salaries of $3,604|
|June 01||Business Transaction||Debit||Credit|
|June 03||Business Transaction||Debit||Credit|
|June 06||Business Transaction||Debit||Credit|
|June 11||Business Transaction||Debit||Credit|
|June 14||Business Transaction||Debit||Credit|
|June 15||Business Transaction||Debit||Credit|
|June 18||Business Transaction||Debit||Credit|
|June 20||Business Transaction||Debit||Credit|
|June 21||Business Transaction||Debit||Credit|
|June 24||Business Transaction||Debit||Credit|
|June 25||Business Transaction||Debit||Credit|
|June 27||Business Transaction||Debit||Credit|
|June 30||Business Transaction||Debit||Credit|
|June 30||Business Transaction||Debit||Credit|
Step 4 – Trial Balance Example – The General Ledger
Step 5 – Trial Balance Example – Create the Trial Balance based on Account Balances from the Ledger
Now it’s easy for you to summarize the ledger balances and see if the totals add up. If they do, then you know that the financial statements your bookkeeper provided you were good. You create a trial balance worksheet and this is what you end up with:
|Your Consulting Company|
|Trial Balance – June|
|Travel and Entertainment Expense||589|
Having seen that the trial balance you prepared balances and it also matches what your bookkeeper put in, you are content.
This topic is not difficult to grasp, practice on your own with another trial balance example or two and become more comfortable with the accounting cycle.
Important Additional Notes to Above Trial Balance Example:
While the trial balance example presented above showed you the basics, in practice things are usually a bit more complicated. It won’t be complicated in terms of principle, but the volume of data you deal with may be significantly higher. In such situations, the possibility of erroneous journal entries are more than likely and in many cases it will be reflected in the trial balance. There are, however, limitations. Certain things that a trial balance won’t pick up on:
- Journal entries to wrong accounts with the correct amounts and balances.
- Missing journal entries all together
- Double posting of the same business transaction
- A erroneous entry that is offset ($) by another erroneous entry.
When you do notice that the debit and credit balances don’t sync up, there are a couple of tactics you can use to narrow down the errors.
- If the difference between the debits and credits is an even number (divisible by 2), divide that number by 2 and check for an entry on the balance side that’s higher for that number. For example, if the difference between debits and credits is $1,000 with debit having the higher balance – divide by 2 to get $500 and now check entries on the debit side for $500.
- If the difference between debits and credits divides evenly by the number 9, it’s possible that there’s a transposed entry. For example, assume a journal entry is supposed to be made by debiting cash and crediting revenue for the amount of $2,981. Now assume that cash was debited for $2,981 but revenue was credited $2,918 – transposing the 8 and 1. In this case, the difference is $63, which is divisible by 9.
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