Trial Balance is the heart of a business. It is a summary of the business activities. It is also an indicator of the financial health of the business. “ If you want to invest in shares of a company, you must study its trial balance” is a commonly heard advice.
What is a Trial Balance?
Multiple entries in various accounts will make a Ledger. Taking all the ledger balances and presenting them in a single worksheet as on a particular date is Trial Balance.
To understand a trial balance, we must first understand the following:
- Double entry system – Recording two entries for a single transaction that is equal and opposite in nature
- Journal – All transactions recorded in double entry system of bookkeeping
- Ledger – Summary of all journals of a similar nature.
Let’s say we buy a book for say Rs. 1000 on credit. Now we receive the book and have to pay money. So this transaction has two activities.
- Buying the book
- Taking credit from seller
In accounting language, recording of this transaction by segregating into two activities is double entry system of bookkeeping.
In the above example let’s assume an organization is trading in books, then the Journal entry will be
In the above example, the Trial Balance as on date will look like the following
Trial Balance as on.….
|To Creditor A/c
||Debit ( Rs )
||Credit ( Rs )
Concept of Trial Balance
Let’s say you record all your activities in a diary. At month end you summarize your diary and classify it into various categories. Now you make a sheet and divide the categories into productive / non productive. That’s exactly what businesses do.
- Recording of transaction is a Journal entry.
- Summarizing them and categorizing them are Ledgers.
- Creating a worksheet and classifying the ledgers is a Trial Balance.
A trial balance is a sheet recording all the ledger balances categorized into debit and credit. A typical trial balance will have name of ledger and the balances. This is prepared as at a particular date which can be financial year end or calendar year.
Advantages of Trial Balance
Given the nature of double entry system, every transaction will result in two entries of equal and opposite nature. Hence at any point in time all debit ledger totals will match to credit ledger totals. Since Trial Balance lists all the accounts as on a particular date, the debit total of a trial balance must match to the credit total.
Therefore a Trial Balance is an indicator of the Arithmetical accuracy of the books of accounts.
With softwares being used for accounting, the above advantage of the trial balance is not very relevant. As data entry systems does not allow entries to be posted if there is a difference in the debit and credit amount hence leaving no room for error.
A trial balance is a summary sheet listing all ledges and balances. Hence it provides a bird eye view of the accounting transactions of an organization.
Prerequisite for preparation of Financial statements
An organization needs to know profit or loss and financial position at year end. And thus to prepare financial statements, Trial Balance is prerequisite. All stakeholders also need this information. It is the first step towards closure of accounts for a particular period.
Uses of Trial Balance
Ease of posting adjustments
A tallied Trial Balance offers significant comfort regarding accuracy and hence post TB adjustments can be affected.
Aids in Audit
Trial Balance gives a list of all ledgers with balances. For the purpose of audit the trial balance is analyzed. For example if the nature of an account is debit, but it holds a credit balance, then the entire ledger will be scrutinized. So trial balance is also an important tool for auditors.
Trial Balance is also used by Banks and lending agencies to understand the borrowing capacity of the business and credibility.
Despite the numerous benefits of a Trial balance, it is imperative to understand that a tallied Trial Balance does not ensure zero errors. If there are offsetting errors, the Trial Balance will tally despite the error.
Also if some transactions have not been recorded,there will be no impact on the ledgers and hence the tallied Trial Balance will pose a wrong picture.
With softwares being used for preparation of accounts, today the Trial Balance from ERP system has automated a lot of processes. It includes ledger codes, ledger names, type of account, balance for the current period, balance for the previous period. Also for large organizations the trial balance can be extracted for any particular period.
Looking at all the pros and cons, it is very clear that preparation of Trial Balance has lot of benefits and hence it preparation has become mandatory for closure of books of accounts. Even today the Trial Balance provides an excellent base for preparation of financial statements and analysis of business.