Trial Balance - Explained
What is a Trial Balance?
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Table of ContentsWhat is a Trial Balance?How is the Trial Balance Used? What is a Ledger Account?What are Debits and Credits?What is an Undetectable Error?
What is a Trial Balance?
A trial balance is an accounting tool. It consists of a bookkeeping worksheet in which the balances of all general ledger accounts are arranged into debit and credit accounts. The columns total in such a way that both column totals balance our (i.e are equal).
The trial balance of a company consists of both its revenue and capital ledger accounts. It is prepared periodically at the end of every reporting period.
Back to: ACCOUNTING, TAX, & REPORTING
How is the Trial Balance Used?
The primary motive behind the preparation of a trial balance by a company is to verify the mathematical accuracy of its bookkeeping system. This is done by identifying and rectifying any errors that may have occurred in its double-entry accounting system.
Once the debit account column in the balance sheet equals the credit account column, a balance is achieved - which means that the company's ledgers are mathematically accurate. However, the absence of errors in the ledgers does not automatically imply that the company's accounting system is accurate. This is evidenced by the fact that a company's trial balance procedure is simply unable to detect missing or erroneously classified transactions. Thus, a trial balance is very likely to present a perfectly balanced worksheet, notwithstanding the presence of significant accounting errors.
What is a Ledger Account?
A ledger account is a bookkeeping account or a record that is used by a company to organize, preserve and summarize its business transactions. A trial balance worksheet uses numerous ledger accounts that have either been debited or credited or used to document multiple business transactions. The trial balance worksheet displays the closing balance of each of the debited and credited ledger accounts. This closing balance is the aggregate of all debits and credits recorded in the individual ledger accounts.
What are Debits and Credits?
A double-entry accounting system records all business transactions in at least two accounts. The account on the left side column of the balance sheet receives all debit entries and is known as the debit account. Similarly, the account on the right side column of the balance sheet receives all credit entries and is known as the credit account.
There is also a third column on the far left of the two columns that displays the account titles. Now, certain accounts such as assets, expenses, dividends or draws and losses are increased with a debit, i.e they should each have a debit balance at the end of the accounting period. Likewise, accounts such as gains, incomes, revenues, liabilities and stockholders equity are increased with a credit, i.e they should each have a credit balance at the end of the accounting period. Nevertheless, there are situations where debit accounts have been credited and credit accounts have been debited during the accounting period. This occurs as a result of certain business transactions that reduce the debit and credit balances of the respective accounts.
What is an Undetectable Error?
Once the debit and credit ledger accounts are listed on the trial balance worksheet along with their individual balances, the debit balances and the credit balances are aggregated separately in order to achieve a perfect balance between the total debits and total credits. A balance in the trial balance worksheet is an indication of accuracy of the double-entry accounting system. Yet, there are certain bookkeeping errors, especially complex mathematical errors, that a simple trial balance is unable to detect. These errors, known as undetectable errors, often arise during the following circumstances:
- When equal debits and credits are recorded in the wrong accounts.
- When a transaction is not recorded.
- When offsetting errors are made simultaneously with both a debit and a credit.
In all the above circumstances, the trial balance will still display a perfect balance between the total debits and total credits.