When people complain about having more month than money, it is often because they are not properly balancing their checkbooks. Just as households can have poor financial habits, so can businesses, which is why they create trial balances. A trial balance is a tool used by businesses to double-check their bookkeeping systems to avoid running short or making crucial accounting errors.
Trial Balance Definition
A trial balance often gets confused with a balance sheet or an income statement. So what is a trial balance? According to Investopedia, it is an in-house report, usually in the form of a spreadsheet, generated at the end of every accounting period. The main purpose of a trial balance is to ensure that the list of credit and debit entries in a general ledger are mathematically correct.
The Importance of a Trial Balance
A trial balance is a critical business tool. When correctly used, it can lead to discovery of financial errors, assessment of profits, and assistance in the internal auditing process of a business.
How Is a Trial Balance Used?
A trial balance lists all the accounts in a general ledger. The debit and credit balances should be equal; any discrepancy in the totals would signal the presence of a mathematical error in the accounting system.
A trial balance can be used to compile financial statements, which reveal the financial health of a business. An income statement, which is a type of financial statement, shows whether a business is profitable. A balance sheet, another type of financial statement, provides detailed information on assets, liabilities, and equity at a given point in time.
Traditionally, the process for compiling financial statements was manually done. Now, with the advent of computerized accounting systems, manual generation of financial statements is no longer necessary.
Who Uses a Trial Balance?
Management can use a trial balance to make sound business decisions. By studying the income statement, management can get a glimpse into their income and expenses over a specific period. With this information, executives can make decisions about the allocation of resources.
A trial balance can assist with the internal auditing process. Auditors can examine the assets indicated on a trial balance and compare them with the physical assets to determine whether material discrepancies exist. Internal auditors can unearth fraudulent activities and notify senior management so they can take immediate action.
Accountants and other members of finance departments use trial balances to help them exercise fiscal control. They can monitor expenses and make decisions that minimize waste and improve efficiencies.
A parent company may require its subsidiaries to calculate and submit their ending trial balances regularly to monitor their financial health. Then the parent company can use these ending trial balances to prepare consolidated results.
What Is a Trial Balance¬¬ Format?
The format of a trial balance comprises the following, according to AccountingTools, a continuing education provider with IRS approval:
- Account number
- Account name
- Ending debit balance (if any)
- Ending credit balance (if any)
The name of the business is centered at the top of the trial balance. “Trial Balance” is centered below the account name. The financial period covered by the trial balance is last. The date appears with the month followed by the day and financial year.
A trial balance has three columns: The first column has general ledger details and account titles. The second column, the debit column, has expenses. The third column, the credit column, has revenue. The balances in the debit and credit columns should be the same. An account can have a negative balance if a checking account is overdrawn; the amount would appear as a negative in the affected column.
What Are the Limitations of a Trial Balance?
While a trial balance is good for ensuring that the credit and debit balances of a business are in agreement, it does not guarantee that the totals will be correct. Errors and fraud can still lurk in either column, despite the agreement in the totals. A trial balance also does not reflect any transactions outside the cutoff date. If these totals were not recorded in the accounting system, they will not be reflected in the trial balance.
Businesses often make the error of entering a debit as a credit and vice versa, which is an error of reversal. It is a difficult error to detect because the corresponding transaction balances out the error. Other errors that are hard to detect are those that are the same amount; if two errors are for $500 each, they could offset each other. The trial balance would appear to be correct, but it would contain the two errors.
These and other errors are limitations of a trial balance. However, it is still a useful tool for businesses to ensure that their accounting is on track. It is the role of the accountant to review the financial statement to discover errors and prepare final reports for the business, which enables the business to remain solvent and profitable.
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