Lesson 17: Trial Balance
In this lesson, we will review the third step in the accounting cycle,
which is creating the trial balances. We will talk about what the trial balance
is used for and its importance. We will then learn how to create the trial
balances and cover some 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.
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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.
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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.
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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.
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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.
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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.
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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.