The main purpose of preparing a trial balance is to assist in the preparation of the year-end Balance sheet. However, before going into more detail about the purpose of a trial balance, let’s briefly look at what a trial balance is. The structure of this article is as follows,
1. What is a Trial Balance?
2. What is the Purpose of a Trial Balance?
What is a Trial Balance
A trial balance is a summarized worksheet which includes all ledger balances as at a particular point in time. It provides all the ending balances in a single document at a glance, thereby it is easy to use as a reference tool. All the debit balances will be recorded in one column while all the credit balances in another. It also assists in disclosing a number of possible errors in case of occurrence and helps to identify the type of journal entries should be posted in order to correct the identified errors. The main purpose of preparing a trial balance is to detect the mathematical accuracy of the ledger balances.
What is the Purpose of a Trial Balance
To use as a Decision Tool
A trial balance can be used as a decision tool to ensure the mathematical accuracy of the journal entries and ledger balances. If all the transactions for an accounting period are accurately recorded, the sum of the debit balances of the trial balance should be equal to the sum of the credit balances.
To Detect and Correct Errors
A trial balance is also used to detect and correct errors in the recording of financial information. The following errors can be identified and should be corrected by posting relevant entries when the trial balance is not in agreement.
|
Error |
Description |
Example |
Corrective entries after preparing the trial balance |
|
Errors of partial omission |
Only the debit entry or the credit entry is posted in accounts |
For credit sale of $ 4,450 to ABC Ltd is not recorded in ABC Ltd account |
ABC Ltd A/C Dr $ 4,450 Suspense A/C Cr $ 4,450 |
|
Errors of casting |
The total of an account is more or less recorded
|
Purchases journal is overcasted by $ 1,500 |
Suspense A/C Dr $ 1,500 Purchases A/C Cr $ 1,500 |
|
Errors of carrying forward |
The ending balance is carried forward incorrectly |
Sales journal balance of $ 5,500 is incorrectly carried forward as $ 5,200 |
Sales A/C Dr $ 300 Suspense A/C Cr $ 300 |
However, it should be noted that there may be other types of errors that do not affect the mathematical agreement of the trial balance, as follows.
|
Error |
Description |
Example |
Corrective entries after preparing the trial balance |
|
Errors of principle |
The entries are posted to the incorrect type of account
|
A sale of building for $ 80,000 is credit to sales |
Sales A/C Dr $ 80,000 Building A/C Cr $ 80,000 |
|
Errors of complete omission |
The entries are completely omitted from the accounts
|
A cash sale of $ 1,100 is completely omitted |
Cash A/C Dr $ 1,100 Sales A/C Cr $ 1,100 |
|
Errors of commission |
An entry is posted in the correct type of account, but the wrong account
|
A cash payment of $ 225 to ABC Ltd is debited to ABB Ltd |
ABB Ltd A/C Dr $ 225 ABC Ltd A/C Cr $ 225 |
|
Errors of compensation |
Incorrect entries in two or more accounts cancel out each other |
Interest income is overstated by $ 400 and sundry expense is understated by $ 400 |
Rent A/C Dr $ 400 Sundry expense Cr $ 400 |
|
Errors of original entry |
Incorrect amount is posted to the correct accounts
|
A credit purchase of $ 2300 from KMN Ltd is recorded for $ 3200 |
KMN Ltd A/C Dr $ 900 Purchases A/C Cr $ 900 |
|
Errors of complete reversal |
Correct amount is posted to the correct accounts but the debits and credits have been reversed
|
A cash payment of $ 100 for inventory is for by debiting cash and crediting inventory |
Inventory A/C Dr $ 200 Cash A/C Cr $ 200 |
To Assist in Preparation of Year-end Financial Statements
Amounts that should be entered into the year-end financial statements such as income statement and balance sheet are derived from the trial balance.
Even though the trial balance is not a year-end financial statement, the statements prepared using the trial balance are vital for giving an impression about the company and arriving at certain financing and investing decisions. Thus, the preparers of trial balance should ensure that the entire accounting process up to the completing of the trial balance is accurate since these balances will be reflected in the financial statements, which in turn is used by many stakeholders.
Uses of financial statements
- To allow comparisons between previous years and industry standards
- For ratio analysis to make decisions regarding profitability, liquidity, and gearing
- To facilitate benchmarking results with similar companies
- To assist preparing budgets for the next financial year
References
“Rectification of Errors – Errors not affecting Trial Balance agreement.” ACCOUNTING-WORLD. N.p., n.d. Web. 26 Jan. 2017.
“Balance sheet example” By Aishakassimkassim1996 – Own work (CC BY-SA 4.0) via Commons Wikimedia
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