How do business owners and chartered accountants check if their books of accounts are correct or not? An incorrectly recorded transaction can have drastic consequences for the business since it might give a skewed view of the business’s financial position.
The best way to check the mathematical accuracy of the books of accounts is to create a Trial Balance.
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What is a Trial Balance?
A trial balance is a summary of all the balances in the ledger account at the end of the accounting period.
Read more: What is a ledger?
Unlike the Journal or the Ledger Book, a Trial Balance is made only at the end of the accounting period – this could be at the end of the quarter, half-yearly, or annually.
It does not record every single transaction, but only the summary of all transactions through that period. The most important function of a trial balance is to ensure that all records are mathematically correct.
A business’s Journal and Ledger books record transactions as they happen, but a Trial Balance only has the summary at the end.
Read more: Journal Entry Explained
Why is a Trial Balance Important?
It is very important for business owners and major stakeholders to be always updated on the financial position of the business. This can be in terms of cash runway, assets owned, amount of debt owed, or other metrics.
All books of accounts follow the double entry principle. This principle states that every transaction has two equal and opposite sides, and both sides must be recorded.
These two sides are called debits and credits.
Read more: Double Entry System
These debit and credit sides are recorded in the Journal and Ledger Books. If this is done correctly, the final balance of the debit side should be equal to the final balance of the credit side.
This can be verified with the Trial Balance. If this verification is not done, the financial position of the business may be wrongly interpreted.
How Does a Trial Balance Work?
A trial balance has two sides: debit and credit. For a trial balance to be considered accurate, the debit and credit sides have to be equal.
It can also be used to keep track of a business’s financial position since the balances of all the different accounts is recorded in one place.
This is how a Trial Balance typically looks.
Trial Balance Format
Under the Ledger Name column, we record the names of all the different accounts recorded in the Ledger Books. Each account, after balancing, ends up with a balance that is either positive or negative.
If the account has a positive balance, it is recorded in the Debit Balance column, and if the account has a negative balance, it is recorded in the Credit Balance column.
Finally, once all accounts have recorded, the sum of the debit and credit column is calculated, and it should be equal.
Here is a list of which accounts typically have a debit and credit balance.
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What is the difference between a trial balance and a balance sheet?
A trial balance is the summary of all the balances in the ledger account. It is mostly an internal document, and is only used to check mathematical accuracy and for an initial view of the business's financial position.
A balance sheet has much more score than a trial balance, since it has balances of not just the ledger accounts but also assets, liabilities and equity. The balance sheet is also a much more formal document, since it follows a format and is published as part of the business's financial statements.
What are the 3 trial balances?
There are 3 kinds of trial balances. For business owners trying to learn more about their business's finances, learning about these different types of trial balances is not important!
But for knowledge's sake:
The 3 types are: unadjusted trial balance, adjusted trial balance and post-closing trial balance.
Why is a Trial Balance used?
A trial balance is used to check the mathematical accuracy of the books of accounts. If a trial balance does not "balance" at the end, it is very likely that there is a mistake in the previous books of accounts!
What is a debit and credit?
When value is added to any account, it is a debit value, and when value is deducted from any account, it is a credit value.