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Trial Balance Purpose for Preparing a Trial Balance Limitations of a Trial Balance Types of Errors

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Trial Balance Purpose for Preparing a Trial Balance Limitations of a Trial Balance Types of Errors Trial Balance Before preparing financial statements at the end of a period, the books must be balanced, i.e. to determine total debits equal total credits. This is determined by preparing a trial balance. A Trial Balance is a list of accounts and their current balances at a given date. It is usually prepared on the last day of the accounting period and the list of account balances are arranged according to debit and credit balances. Debit balances are listed in one column and credit balances are listed in another. The two column totals should be equal. When this occurs, the ledger is said to be inin balance.. Purpose for Preparing a Trial Balance The primary purpose of a Trial Balance is to prove the mathematical equality of debits and credits in the ledger. According to the double-entry system of recording, if a debit and a credit have been made for each transaction, the total of the debits should be equal to the total of the credits. If the accounts are balanced off and their balances compared, the total of debit balances should be equal to the total of credit balances. In addition, the Trial Balance is useful in the preparation of the Trading and Profit and Loss Accounts, and the Balance Sheet since it lists all the account balances in the ledger. •• Note: a trial balance is prepared for two reasons - i.i. To check the arithmetic accuracy, i.e. The debit totals and the credit totals should be equal if the double- entry system of book-keeping is followed. ii.ii. To write up the financial statements, i.e. Trading and Profit & Loss Accounts, and Balance Sheet.t. Limitations of a Trial Balance Although the Trial Balance is used to prove the accuracy of the double-entry system of recording, it has its limitations. A Trial Balance that balances does not prove that all the transactions have been recorded or that the ledger is correct. This is because numerous mistakes may exist even though the Trial Balance totals are in agreement. Types of Errors Errors can be classified into two categories - •• Errors not revealed by the Trial Balance •• Errors revealed by the Trial Balance Errors Not Revealed d by the Trial Balance The following errors do not affect the equality of the Trial Balance totals: 1.1. Errors of Omission: A transaction is omitted completely from the books so that there is no debit and credit entry of the transaction, e.g. Drawings of $50 cash by the proprietor was not recorded. 2.2. Errors of Commission: An entry is posted to the correct side of the ledger but to the wrong account, i.e. items have been posted to the wrong account of the same class, e.g. Payment of $100 cash by a customer A. John was wrongly posted to the account of another customer, B. Johan. 3.3. Errors of Principle: An entry is made in the wrong class of account, i.e. when an expense is treated as an asset and vice versa, e.g. Repairs to building $400 was debited to the Building Account. 4.4. Complete Reversal of Entries: An account that should be debited is credited and vice versa, e.g. A cheque $200 received from Cyril was debited to the account of Cyril and credited to the Bank Account. 5.5. Compensating Errors: Errors (or error) on one side of the ledger are compensated by an error (or errors), e.g. The Purchases Account and Sales Account were both overcast by $150. 6.6. Errors of Original Entry: The original figure may be incorrectly entered although the correct double-entry principle has been observed using this incorrect figure, e.g. Credit sales of $87 to Kay was recorded in the Sales Account and Kay's account as $78. Errors Revealed by the Trial Balance Errors which are revealed by the Trial Balance are those errors which cause the Trial Balance totals to be in disagreement. 1.1. Errors in Calculation: If there is any miscalculation of the Trial Balance totals or the net account balances, the Trial Balance will not balance, e.g. There was an error in the calculation of the cash balance, causing the Trial Balance totals not to balance too. 2.2. Errors in Omission of One Entry: Omission of either the debit or credit entry of a transaction will cause the totals of the Trial Balance not to agree, e.g. A cheque $500 received for commission was debited to the Bank Account only. 3.3. Posting to the Wrong Side of An Account: Entry into the wrong side of an account will cause one side of the ledger to be more than the other, e.g. A cheque of $800 paid to creditor, K. Wang was credited instead of debited to his account. 4.4. Errors in Amount: If the debit entry of a transaction differs in amount with the credit entry, the Trial Balance will not balance, e.g. Cash $134 received from Caine was debited to the Cash Account as $134 and credited to the account of Caine as $143. Summary •• An account has a debit balance when its debit total exceeds its credit total. •• An account has a credit balance when its credit total exceeds its debit total. •• Asset, expenses and drawings accounts have debit balances. •• Liability, capital and revenue accounts have credit balances. •• A Trial Balance is a list of debit and credit balances extracted from the accounts in the ledger at a particular date. •• The Trial Balance is prepared for the purpose of checking the arithmetical accuracy of the entries made in the ledger. •• The total debit balances will equal the total credit balances in the Trial Balance if the double-entry principles of recording have been strictly adhered to.to. •• Errors that effect the agreement of the Trial Balance totals are wrong calculation of balances, omission of either a debit or credit entry of a transaction, entry on the wrong side of an account, and errors in amount. •• Errors that do not affect the agreement of the Trial Balance totals are complete omission of entries of a transaction, errors of commission, errors in principle, compensating errors, and errors in original entry. •• Asset and liability accounts are balanced and their balances brought down to the next accounting period. Personal accounts record transactions with persons who have dealings with the business, e.g. debtors and creditors accounts. Accounting concepts and conventions In drawing up accounting statements, whether they are external "financial accounts" or internally-focused "management accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation. The theory of accounting has, therefore, developed the concept of a "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities. To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently. Accounting Conventions The most commonly encountered convention is the "historical cost convention". This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost. Under the "historical cost convention", therefore, no account is taken of changing prices in the economy. The other conventions you will encounter in a set of accounts can be summarised as follows: Monetary measurement Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc. Separate Entity This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business. Realisation With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms. Materiality An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts. Accounting Concepts Four important accounting concepts underpin the preparation of any set of accounts: Going Accountants assume, unless there is evidence to the contrary, that a Concern company is not going broke. This has important implications for the valuation of assets and liabilities. Consistency Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change. Prudence Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future.
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