What is a trial balance and why is it prepared?
Meaning
A trial balance is an in-house report generated by a company or business at the end of every accounting period and presented as a spreadsheet that lists all the accounts and their balances at a given time. It summarises the balances of all accounts in the general ledger.
A trial balance is a critical business tool enabling businesses to uncover financial errors and assist in internal auditing.
The purpose of trial balance
The primary purpose of the trial balance is to ensure that the total debits equal the total credits and that the accounting records are accurate and complete. The trial balance serves several important purposes:
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Identifying errors: If the total of the debits and credits does not match, it indicates an error that must be identified and corrected. Also, internal auditors can uncover fraudulent activities and inform senior management for prompt action.
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Preparing financial statements: The trial balance is used to prepare financial statements such as the balance sheet, income statement, and cash flow statement.
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Facilitating analysis: Reviewing the balances of different accounts, such as accounts receivable & accounts payable, enables one to gain insight into the company's financial health and make informed business decisions.
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Enhance business efficiency: Accountants or bookkeepers can use trial balances to exercise fiscal control, monitor expenses, minimise waste, and improve business efficiencies.
What are the three types of trial balance in accounting?
There are three types of trial balance:
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Unadjusted trial balance: As the name implies, it is prepared before any account adjustments are made. It identifies any errors or omissions in the accounting records before adjustments are made.
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Adjusted trial balance: It is made after adjusting entries to the accounts at the end of an accounting period. Adjusting entries are made to update accounts for accruals, deferrals, and other adjustments needed to reflect the company's financial position accurately. The adjusted trial balance ensures that all debit balances are equal to all credit balances after making adjustments.
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Post-closing trial balance: It is only prepared after all the closing entries have been made to the accounts at the end of any accounting period. Closing entries are created to transfer balances from all temporary accounts to permanent accounts. Post-closing trial balance ensures all debit and credit balances are equal after all closing entries are made and is the starting point for the subsequent accounting period.
What are the basic rules of trial balance?
Trial balance format
The format of a trial balance may vary depending on the software or accounting system, but the general structure remains the same. A trial balance is usually prepared at the end of an accounting period, such as a month or a year.
A trial balance contains three columns:
- Column 1 : the left column contains general ledger details and account titles
- Column 2 : the debit column with expenses
- Column 3 : the credit column with revenues
| Formula for Trial Balance: Total Debit Balances = Total Credit Balances |
The balances of all accounts in the general ledger are transferred to the trial balance, and the total of each column should be equal. If the two columns (debit & credit) do not balance, it indicates an error in the accounting records. An accountant can then review the accounts and make necessary adjustments to correct the error.
What is balancing in accounting?
Balancing refers to equalising the debit and credit side of the account. If you want to balance an account, you must adjust the debit and/or credit entries so that at the end of the period the amount in the debit and credit lines is the same.
Example of trial balance
| Account | Debit (€) | Credit (€) |
|---|---|---|
| Cash | 3,500 | - |
| Accounts Receivable | 2,000 | - |
| Inventory | 4,000 | - |
| Equipment | 10,000 | - |
| Accumulated Depreciation | - | 2,000 |
| Accounts Payable | - | 4,000 |
| Bank Loan | - | 5,000 |
| Capital | - | 7,250 |
| Sales Revenue | - | 14,000 |
| Cost of Goods Sold | 8,000 | - |
| Rent Expense | 1,500 | - |
| Utilities Expense | 750 | - |
| Salaries Expense | 2,000 | - |
| Insurance Expense | 500 | - |
| Total | 32,250 | 32,250 |
In this trial balance, the total debit balance is €32,250, and the total credit balance is €32,250, which means the books are balanced.
Trial balance vs Balance sheet
Trial balance: Often confused with a balance sheet, a trial balance is actually a tool for preparing a balance sheet and ensuring that the accounting records are accurate and complete. The objective of the trial balance is to ensure that all debits are equal to all credits, which indicates that the accounting records are in balance.
Balance sheet: A balance sheet is a financial statement notifying the assets, liabilities, and equity of a company at a specific time. A balance sheet is prepared using the balances of the accounts listed in the trial balance. It also includes additional information such as current and long-term assets and liabilities, retained earnings, and other equity accounts.
How does a trial balance help cash flow management?
While a trial balance does not directly impact cash flow management, it plays a vital role in ensuring the accuracy of financial information. It can provide valuable information to help you better manage your cash flow. For example, by reviewing your accounts receivable and accounts payable balances in the trial balance, you can get an idea of the amounts you are owed by customers and the amounts you owe to vendors. This information can help you prioritise your cash outflows and inflows, allowing you to manage your cash flow better.
By reviewing the balances of your cash and bank accounts in the trial balance, you can ensure that you have sufficient cash on hand to meet your immediate needs, such as paying bills and meeting payroll.
You can better understand your company's cash position and make informed decisions about cash flow management, such as investing excess cash or seeking financing to cover short-term cash needs.
The bottom line
Trial balance is a valuable tool for businesses that ensures their accounting is on track enabling the business to remain solvent and profitable. Additionally, to assess any business's borrowing capacity and credibility, banks and lending agencies utilise the trial balance.
While a trial balance is not the only solution to detect all accounting errors, it is definitely an essential step in the accounting process since the entire accounting exercise rests on it.
