Trial Balance: How to Prepare It, Its Uses and Its Limitations

Once transactions are posted, every ledger account holds a mix of debit and credit entries. The trial balance collects the net position of each account on one page and tests whether the double entry has been carried out correctly. It is also the starting point for the financial statements.

This topic shows how to close off a ledger account, how to draw up a trial balance, what an agreement between its two columns does and does not prove, and how the trial balance leads to the statement of profit or loss and the statement of financial position.

The trial balance is a reliable source of marks. In the 20 diets reviewed, a trial balance was extracted in a Section B question in about one diet in four, and the definition, the uses and the errors it does not reveal appeared as short parts in several more.

Section A adds one or two items a diet, for instance which items sit in the debit column or which error leaves the totals equal. Read double entry bookkeeping, journal entries and ledger accounts first. The topic after this one covers the books in which transactions are first recorded.

Closing off an account and bringing down the balance

The balance on an account at any time is the difference between the total of its debit entries and the total of its credit entries. The procedure has four steps.

1. Total both sides of the T account and write the larger total on both sides, on the same line, leaving a gap above it.
2. Enter the balancing figure on the side that adds up to less. Label it Balance c/d (carried down), or Balance c/f (carried forward).
3. Check that both sides now show the same total.
4. Write the balancing figure on the opposite side, below the totals, and label it Balance b/d (brought down), or Balance b/f. This is the closing balance and becomes the opening balance of the next period.

If the debit entries exceed the credit entries, the balance c/d is written on the credit side and the balance b/d appears on the debit side. If the credits exceed the debits, the reverse applies. In practice the subtotals in step 1 are often skipped and the working goes straight to the balancing figure.

Here the debits total 1,870 and the credits total 1,130. The difference of 740 is written on the credit side as balance c/d and brought down as a debit balance, which means the business has 740 in the bank, an asset.

The balances on income and expense accounts are transferred to the statement of profit or loss, while the balances on asset, liability and capital accounts are carried forward as the opening balances of the next period.

The trial balance

If every double entry was posted correctly, the total of all debit entries in the ledger equals the total of all credit entries. It follows that, if a balance is taken from every account, the sum of the debit balances equals the sum of the credit balances. A trial balance is a list of all the debit balances and all the credit balances from the accounts in the main ledger.

It is presented in two columns and carries a date, because it shows the position at one moment.

For the Kaduna Hardware example used in this topic, the closed-off accounts give these balances (₦’000): bank 740 debit, receivables 100 debit, equipment 500 debit, purchases 640 debit, rent 60 debit, wages 90 debit, drawings 80 debit, payables 240 credit, sales 670 credit, capital 1,000 credit and loan 300 credit.

Uses of a trial balance

The uses are listed below.

• Check on arithmetical accuracy. Equal totals show that the debits and credits posted are equal.
• Basis for the financial statements. It is the foundation for the statement of profit or loss and the statement of financial position.
• Error detection. It shows certain mistakes: unequal debits and credits, an entry on one side only, and wrong amounts or sides in the extraction.
• Summary of ledger balances. One page shows every balance, which helps analysis.
• Adjustments. It is the place where depreciation, accruals, prepayments, bad debts and inventory are identified before the statements are prepared.
• Audit trail. It is a reference point for auditors.
• Time saving. It brings all balances together.

Limitations: errors the trial balance cannot reveal

A trial balance that agrees is not proof that the books are right. It shows that debits equal credits and nothing more. Errors that leave both totals changed by the same amount stay hidden. There are four.

• Omission. A transaction is left out of the books entirely, so neither side is affected.
• Commission. The correct amount is posted, but to the wrong account of the same type, for example to the wrong customer.
• Principle. A transaction is posted to the wrong class of account, for instance a capital expense treated as a revenue expense.
• Compensating errors. Two errors of equal amount on opposite sides cancel each other.

The trial balance does not show fraud, because falsified entries may still balance. It does not confirm that balances are in the right class of account, so an asset booked as an expense passes unnoticed. It tests numerical accuracy but not whether the records are complete or appropriate. And it is not a financial statement. It must be adjusted and then converted into statements for users.

Background: other errors that do not affect the totals, and errors that do. The examiner has asked for lists of both kinds. Errors of original entry (a wrong amount entered in both accounts) and complete reversal (debit and credit posted to the right accounts but on the wrong sides) also leave the totals equal.

Errors that make the totals differ include a casting error (a column added up wrongly), a transposition of figures in one entry, posting only one side of a transaction, omitting an account balance from the trial balance, entering a balance on the wrong side, and extracting a wrong amount from a ledger account.

From the trial balance to the financial statements

The trial balance is the foundation for the statements. Year-end adjustments are made to it first. They include depreciation, accruals and prepayments, bad and doubtful debts and inventory. The statements are then prepared from the adjusted balances. The first step is to identify what each balance is: an asset, a liability, equity, income or an expense.

The only adjustment in the Kaduna Hardware example is closing inventory of ₦200,000, found by a stock count at the year end. Purchases show the goods available for sale. Closing inventory is the goods still unsold, and it is deducted. The result is the Cost of sales: opening inventory + purchases − closing inventory.

Closing inventory is recorded by Dr Inventory (an asset) and Cr Cost of sales in the statement of profit or loss, as the previous topic showed.

The ideas in more depth

What equal totals actually test

Equal totals test the arithmetic of the double entry: for each transaction, a debit of one amount was matched by a credit of the same amount. They do not test whether the right accounts were chosen, whether every transaction was recorded, or whether the amounts match the documents. That is why the next topics on errors and suspense accounts exist.

A balance on the wrong side moves the totals by twice its size

Suppose the receivables balance of ₦100,000 in the example above was listed in the credit column by mistake. The debit column loses 100 and the credit column gains 100. Debits become 2,110 and credits 2,310. The difference is 200, which is twice the 100. A balance of ₦9,000 on the wrong side gives a difference of ₦18,000, the same rule that a Section A item has tested. If a balance is simply left out, the difference equals its size.

Leaving out the bank balance of 740 would leave debits of 1,470 against credits of 2,210, a difference of 740.

Dividing the difference by two

This gives a clue. When a trial balance fails to agree by an even amount, one explanation is a balance on the wrong side, and you look for a balance of half the difference. A difference equal to one balance suggests an omitted balance or an entry posted to one side only.

The trial balance is not a statement

The statement of profit or loss and statement of financial position are the formal reports. The trial balance is a working paper. It lists inventory only if an inventory account was set up, and under the periodic approach used so far it contains purchases, not cost of sales. This is why closing inventory is added when the statements are prepared.

Sources and references

Worked example: closing accounts and extracting a trial balance

1. Bank.
   Debits 1,000 + 420 + 150 + 300 = 1,870.
   Credits 500 + 260 + 60 + 90 + 80 + 140 = 1,130.
   Balance: debit 740.
2. Receivables. Debits 250 less credits 150: debit 100.
3. Payables. Credits 380 less debits 140: credit 240.
4. Purchases and sales.
   Purchases: 260 + 380 = 640 debit.
   Sales: 420 + 250 = 670 credit.
5. Trial balance.
   Debits: 740 + 100 + 500 + 640 + 60 + 90 + 80 = 2,210.
   Credits: 240 + 670 + 1,000 + 300 = 2,210.
   The totals agree.
6. Effect of a mistake. If receivables of 100 were put in the credit column, debits would be 2,110 and credits 2,310, a difference of 200, which is 2 × 100.
7. Profit.
   Cost of sales = 0 + 640 − 200 = 440.
   Gross profit = 670 − 440 = 230.
   Expenses 60 + 90 = 150.
   Net profit = 230 − 150 = 80.
8. Check.
   Total assets 500 + 200 + 100 + 740 = 1,540.
   Capital 1,000 + 80 − 80 = 1,000, plus loan 300 and payables 240, gives 1,540.
   The statement of financial position balances.

Common mistakes in the exam

• Saying that an agreeing trial balance proves the books are correct. It proves only that debits equal credits.
• Putting drawings in the credit column, or capital in the debit column.
• Bringing a balance down on the wrong side, or writing balance c/d on the same side as the larger total.
• Listing only the names of the four hidden errors without saying why each leaves the totals equal.
• Forgetting the date on the trial balance.
• Treating the trial balance as a financial statement.
• Dividing a difference caused by a wrong-side balance by two, or doubling the size of an omitted balance. An omitted balance changes the totals by its own size.

Quick revision

• Close off: total both sides, balance c/d on the smaller side, balance b/d on the opposite side below the totals.
• Trial balance: all ledger balances, in two columns, with a date.
• Debit column: assets, expenses, drawings. Credit column: liabilities, income, equity.
• Uses: arithmetical check, basis for statements, error detection, summary, adjustments, audit trail.
• Hidden errors: omission, commission, principle, compensating. Also original entry and complete reversal.
• Wrong-side balance: the totals differ by twice its size. Omitted balance: the totals differ by its size.
• Cost of sales = opening inventory + purchases − closing inventory.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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