Trial Balance Definition, How It Works, Purpose, and Requirements

In the words of J.R Batliboi, "A trial balance is a statement, prepared with the debit and credit balances of the ledger accounts to test the arithmetical accuracy of the books."

A trial balance gets prepared just before preparing final accounts, which includes a balance sheet, Profit and loss statement, Cash flow, and notes to Accounts. In layman's terms, we can assume that it is the basic structure behind preparing the final accounts. It is the third step in the road map to prepare final accounts after the entries are passed in journal-register followed by classification and grouping of transactions to their respective ledgers. These ledgers, i.e. the principal book containing all sets of accounts, are then accumulated in a single place to constitute a Trial balance.

Purpose of Trial Balance

The preparation of the trial balance helps in developing financial statements. The assets and liabilities find their place in the balance sheet. The Income and expenses appear in the profit and loss account. Based on all these accounts, the preparation of Final accounts takes Place.

Features of Trial Balance

1. Trial balance in accounting lists down all the ledgers, including the cash book.

2. It does not form a part of the Double-entry System of Accounting. It serves only as a reference.

3. A trial balance can be prepared any time- weekly, monthly, quarterly, and year-end.

4. It serves as a vital tool to verify the arithmetical accuracy of the books.

5. It forms a connecting point between the Profit and Loss Account and Balance sheet.

6. It does not provide conclusive proof of the absence of error. Errors such as errors of principal may still exist.

Objectives of Trial Balance

1. Bird Eye View: The trial balance gives the summary of all the ledgers. Since the net amount gets displayed, you can save time by not viewing the concerned ledger again.

 2. Pointing out Error: The trial balance aids in pointing out errors. It is also used to check the arithmetical accuracy of books of accounts.

Limitations of Trial Balance

1. The error of principle and compensating error may still exist even after the trial balance matches.

2. The trial balance matches even when the transactions are completely omitted from recording in the books if they are not accounted for.

Methods of Preparation of Trial Balance

Two methods used in the preparation of the trial balance are:

1. Balance Method: In this method, it is the net amount of a ledger that gets displayed in a trial balance. It can either be debit or credit balance. Under this method, the trial balance can be prepared only after all the accounts get balanced. This is one of the accurate methods for the preparation of final accounts.

2. Totals Method: In this method, the total of each side of the account (debit and credit) gets posted in the trial balance. This method provides higher mathematical accuracy. However, the preparation of final accounts is not usually conducted using this method because of the scope of duplication, resulting in errors. 

Steps to prepare Trial Balance

Step 1: Understanding the Golden Rule of accounting: Understanding the golden rules of accounting is vital. It helps in understanding which account needs to be debited and which needs to be credited. As per the golden rule, debit comes under Expenses and assets and credit under incomes, gains, and liabilities. Therefore, credit is payables, whereas debit is receivables.

 Step 2: Pass the journal entries: After making sure which account is debited or credited, a necessary journal entry is passed. If you are using Tally ERP 9, the entries get passed automatically when the amount is input.

Step 3: Once the journal entries get passed, post the entries into their respective ledgers. In the case of Tally ERP 9, this posting takes place automatically at the back end. If you are maintaining manual accounts, then post them manually into the respective accounts.

Step 4: In this step, all the ledgers get routed to the trial balance. If there is no arithmetical mistake, the debit and credit sides will match up. In case of any difference, record the same in the suspense account. 

Errors that cause a mismatch in Trial Balance

Both sides of a trial balance must tally. But if that does not happen, it may be on account of the following reasons.

1. When only one leg of the transaction is posted: Suppose goods are purchased on credit. The Purchase account gets debited, but the Creditor's account was not credited.

2. Lack of accurate balancing: The Closing balances of the previous year have not been accurately balanced in the current year.

3. Amounts mismatched: Suppose the sales ledger has a credit balance of Rs 10000, but while posting it in the trial balance, Rs 1000 gets posted. As a result, there will be a mismatch of Rs 9000 in the trial balance.

4. Mismatch issue: Suppose that the prepaid rent is paid. Instead of debiting the prepaid rent account, the Vendor's account gets debited. This will cause a mismatch in the trial balance.

Errors Not Reflected by Trial Balance

1. Omission: In this case, if a transaction gets missed in its entirety; the same will not get detected by the trial balance.

2. Error of Principle: The trial balance will still match if a transaction gets recorded against the generally accepted accounting principle. The error of principle includes recording the Capital transaction as a revenue transaction in the books of accounts.

3. Error of Commission: Suppose Rs 5000 gets recorded as Rs 500 in both the debit and credit sides  of the trial balance. The trial balance w ill fail to point out this error.

4. Compensating Error: In compensating error, one error compensates for another. For example, you did not debit the purchase account of Rs 1000 in one account but by mistake debited Rs 1000 in another account.

Also Read: Fund Flow Statement: Definition, Format with Example 

Important Principle used in the Preparation of Trial Balance

1. All the nominal, personal, and real accounts are to be considered in preparing the Trial balance.

2. If a ledger shows a NIL balance, it is not considered in the preparation of the trial balance.

3. The purchase or consumption ledger always carries a debit balance and appears on the debit side of the trial balance.

4. The revenue account always carries a credit balance and appears on the credit side of the balance sheet.

5. Sales return and purchase return can appear as separate line items in the trial balance or be shown as reduced from the main purchase and sales ledger, respectively.

6. Opening stock figure comes from the Profit and loss account since it is not available as a closing balance of stock in the previous year's trial balance.

7. All the expenses generally carry a debit balance. Accordingly, they will appear with a debit balance in the trial balance.

8. All the incomes and gains generally carry a Credit balance. Accordingly, they will appear with a credit balance in the trial balance.

9. The asset and liability must tally at the end.

Format of Trial Balance

The trial balance has two formats, such as:

1. Journal Format: This is as per the format of a journal Folio. Under this format, there is a column for the serial no., account name, ledger folio, the amount of debit and credit.

2. Ledger Format: This form of trial balance features two sides for debit and credit. Each side will have the name of the ledger and the net amount of the ledger in the amount column.

Here’s an example:  

Accounts in trial Balance

The debit side of the trial balance has:

• Assets- Cash, Inventory, Building, land, plant, and Machinery.
• Trade Receivables- Debtors and Bills receivables.
• Expenses- Wages and salary.
• Losses- Loss on sale of PPE, land, etc., other than inventory.
• Consumption and Purchase Account

The Credit Side of the Trial Balance has:

• Liabilities- Expenses payable, Short term bank credits, loans, and other borrowings.
• Trade Payable- Bills payable and sundry creditors
• Sales and Revenue
• Profit and Gain- Profit on sale of assets such as land, building, or PPE.
• Reserves- These include accumulated Depreciation reserve, General reserve, Securities Premium, etc.

How to view Trial balance is tally ERP 9?

Step 1: Start with the gateway of the tally.

Step 2: Under the report section, click on Display to redirect you to the Display Menu.

Step 3: Click on the Trial Balance

The trial balance window will then appear on your screen. 

Enhanced Uses of Trial Balance

These days the accounting software prepares the trial balances by themselves. There is hardly any chance of a mistake in the trial balance prepared by them. But still, the presence of trial balance carries a lot of significance. For example, the auditor can use the same to track deviation from the previous year's figure. Based on that deviation, they can base their audit approach. For example, Khatabook is one such app that aids in providing a digital ledger so that it's easier to manage trial balances.

Also Read: Cost Of Capital – Definition, Formula, Calculation and Example 

Conclusion

The preparation of trial balance is a common practice before preparing the final accounts of the company. It is in line with the maker and checker concept of Internal control. Preparation of final accounts takes time, so the management can understand the company's financial status via the trial balance until it is prepared. They can take business decisions based on the trial balance generated as of date. Thus, it forms an integral part of business accounting, and with the aid of Khatabook, small business owners can learn more about trial balance and execute them with ease.