Lesson Objectives:- What the trial balance is used for
- Importance of the trial balance
- How to create the trial balances
- Potential errors associated with this step
Preparing the trial balance is the third step of the accounting cycle; it uses information from the previous step of the general ledger balances.
Let's use the same entries that we reviewed when looking at the T-accounts in the previous lesson. Just as when we reviewed the general ledger in the last lesson, most trial balances will include more accounts. But for the purpose of this introductory accounting course, we will cover a few of the most common account types.
Above is an example of a full trial balance; later we will be reviewing a simpler example step-by-step.
Not only is the trial balance a vital step in the accounting cycle, it is an important part of ensuring financial statements are accurate. Companies can easily check the accuracy of their trial balance, as the credit side must equal the debits side, similar to how the accounting equation must balance. If the two sides are not equal, the journal entries and general ledger would need to be recalculated to ensure there are no errors.
Without performing the trial balance, the company would be estimating the income and they would be much more likely see errors on the balance sheet and other financial statements. Even smaller-sized business cannot accurately guess on their financial statement, hence the need for the accounting cycle and trial balances.
The first thing we need to do is extract the final balances from each T-account and fill this information into our trial balance. This step is called the trial balance because the end goal is to make sure the debit and credit entries from all accounts are balanced, meaning the total debits equal the total credits.
Take a look at the example above; the trial balance is broken down by debits and credits for each type of account. The final balances from each T-account are pulled out and posted on the appropriate side next to the account name. As you can see the debit balances remain on the left and the credits on the right.
For the purpose of this lesson, we are reviewing a few accounts so keep in mind the same concepts apply to a real trial balance but a company can often have dozens or hundreds of different account types. Similar to the order of the accounting equation, in the trial balance we list the asset accounts first, then the liabilities accounts and ending the list with the equity accounts.
The final balances are totaled on both sides underneath a single line. Below the trial balance amounts, we put double lines. We know ABC Building Supplies' trial balance is correct because the debits amount of $13,500 is equal to the credits amount of $13,500.
While both sides equal out on the trial balance, there still is room for errors.
Let's look at a few common errors that can take place when creating the trial balance.
Transposition errors could occur if the values credited and debited are not accurate. Such as if an entry for accounts receivable and revenue were recorded as $900 for the credit and $900 for the debit, when the correct amount should have been recorded as $1,100 and $1,100. While the trial balance would still equal out, the journal entries wouldn't be accurate.
Duplicate entries take place when entries are recorded twice for the same transaction. For example, if the accounts receivable account was debited twice for $1,100 and revenue was credited twice. Again, the trial balance would still show debits equaling credits.
Wrong accounts can be used for either the credit or debit entries. For example, if the cash account was debited when the correct account that should have been debited was the accounts receivable. This third example could also result in the trial balance equaling out.
As you can see the trial balance does not completely avoid accounting errors, it just helps the company to ensure debits balances are equal to the credit balances.
Although it doesn't make the company's financial statements completely error-proof, the trial balance is a critical step in the accounting cycle that helps to ensure the debit balances are equal to the credit balances.