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Bookkeeping – Debits and Credits with the Trial Balance (Lesson 16)

Lesson 16

The primary report used by accountants is the trial balance. It is the job of the bookkeeper to make sure that it is in balance and that there are no abnormal values within the respective types of accounts. This lesson sums up the prior 15 lessons and illustrates the trial balance with a condensed version and an expanded version. Finally I provide some insight into interpreting the trial balance and explain why there is no ‘Current Earnings’ line on the trial balance (T/B). From this point forward I’ll use the short hand of T/B to represent the term trial balance.

Trial Balance Organization

In simple presentation format the T/B is laid out with all six types of accounts in the following order: See Lesson 1 for types of accounts.                                  

                                Trial Balance
                                           Date
Name of Account       DR                CR
 Assets               $Z,ZZZ,ZZZ
Liabilities                                    $ZZZ,ZZZ
Equity                                            ZZZ,ZZZ
Revenue                                     Z,ZZZ,ZZZ
Cost of Sales       Z,ZZZ,ZZZ
Expenses                ZZZ,ZZZ   
                           $Z,ZZZ,ZZZ  $Z,ZZZ,ZZZ 

As explained in Lesson 2, all debits MUST equal credits in the summation line. In addition the first three types of accounts represent the balance sheet and the last three identify with the income statement A.K.A. profit and loss statement.

Also notice three types of accounts carry ending balances that are debit driven and the other three have credit values.

Ending Balances in Each Type of Account

For the bookkeeper it is key that each respective type of account carry the proper value (debit or credit) as its ending balance. I explain this in detail in Lessons 4 through 8 and in Lesson 10. If you need a refresher, here are the links to each respective account type:

Assets – Lesson 4
Liabilities – Lesson 5
Revenue – Lesson 6
Cost of Sales – Lesson 7
Expenses – Lesson 8
Equity – Lesson 10

Key Business Principle

THE JOURNALS ACT AS THE SOURCE ENTRY POINT FOR RECORDING THE PROPER DEBIT AND CREDIT TO THE BOOKS OF RECORD. REVIEW LESSON 3.

I can’t emphasize enough the importance of making sure that in the aggregate each of the respective types of accounts end with the correct form of value i.e. debit or credit.

Assets – Debit Balance
Liabilities – Credit Balance
Equity – Credit Balance
Revenue – Credit Balance
Cost of Sales – Credit Balance
Expenses – Debit Balance

Proper Presentation of Each Account

When this report is printed it naturally identifies the name of the company, the report title and date in the heading.

Most trial balances use the five column presentation format as follows:

Account Type  Account Group  Account Name DR  CR

The account type refers back to one of the six types of accounts. The account group identifies the major groups of accounts in each account type as follows:

Account Type  Account Group
ASSETS
                               Current
                               Fixed
                               Other

LIABILITIES
                               Current
                               Long-Term

EQUITY
                               Stock
                               Other Stock
                               Retained Earnings

REVENUE
                               Sales
                               Other

COST OF SALES
                               Materials
                               Labor
                               Equipment
                               Other

EXPENSES
                               Management
                               Facilities
                               Office
                               Insurance
                               Other

To take this to the next level, lets look at one group of accounts within the asset type of accounts:

ABC CORPORATION
Trial Balance
Date

Account Type  Acct Group  Ledger Acct                     DR            CR
ASSETS                Current           Cash on Hand               ZZZ
ASSETS                Current           Checking – Ops        ZZ,ZZZ
ASSETS                Current           Checking – PR          ZZ,ZZZ
ASSETS                Current           Inventory                    Z,ZZZ
ASSETS                Current           Accounts Rcv           ZZ,ZZZ
ASSETS                Current           Reserve – Bad Debt                     Z,ZZZ
ASSETS                Current           Prepaid Expenses     ZZ,ZZZ

Hopefully every reader caught the credit balance for the reserve account. This is an example of how a contra account balance is reported on the trial balance. If you are uncomfortable with contra accounts, be sure to review Lesson 12.

Also note that I did not sum up the debits and credits. If I had, they would not be equal. This is because this is just one subsection of the trial balance. Your debits and credits must be equal for the entire trial balance.

One more little note, when addressing contra accounts I discuss using parenthesis with contra accounts. Did you notice any parenthesis with the one above? Why?

The answer is that the trial balance is not a formal financial statement. It is an accountant’s tool only. The parenthesis around contra and atypical accounts are only used with the formal financial statements.

Full Detail Trial Balance Example

The following is a full detailed example of a contractor’s trial balance for illustration:

                                             NAILED IT CONSTRUCTION INC.
                                                              Trial Balance
–                                                      December 31, 2015

Acct Type  Acct Group  Ledger Name                      DR                  CR
A                    CA               Cash on Hand                     143
A                    CA               Operating                        41,717
A                    CA               Payroll Checking              3,201
A                    CA               Vendor’s Cash                     988
A                    CA               Work in Process           293,776
A                    CA               Contract Rcvbl               53,200
A                    CA               Prepaid Insurance           14,102
A                    Fixed          Site Equipment                35,413
A                    Fixed          Transportation                  51,775
A                    Fixed           Accmltd Dprc                 77,203
A                    Other          Land-Future Use              57,202
L                     CL               Accounts Payable                                28,747
L                     CL               Credit Cards                                         16,482
L                     CL               Accrued Payroll                                     7,011
L                     CL               Progress Billings                                267,413
L                     CL               Taxes Due                                            18,408
L                     Long Term Truck Note                                            14,809
L                     Long Term Kubota Note                                            3,497
C                    Stock            Common Stock                                      1,000
C                    Stock            Capital Paid in Excess                         19,000
C                    RE                 Retained Earnings                               50,545
C                    RE                 Distributions                20,400
R                    Sales             Contract Income                             1,393,742
R                    Sales             Closing Costs                67,411
R                    Sales             Allowances                   27,400
R                    Other Rev   Compliance Fees                                     8,100
R                    Other Rev    Interest                                                       207
COS              Direct            Materials                     402,888
COS              Direct            Labor                           201,440
COS              Direct            Subcontractor              293,875
COS              Direct            Equipment                     29,915
COS              Direct            Other                             22,409
COS              Indirect        Project Mngmnt           172,644
COS              Indirect        Transportation                18,591
COS              Indirect        Insurance                        17,996
COS              Indirect        Communications              7,040
COS              Indirect        Tools                                 6,738
E                    Staff              Payroll                          28,604
E                    Facilities      Rent                               13,400
E                    Facilities      Maintenance/CAM          3,092
E                    Facilities      Utilities                            2,694
E                    Office            Supplies                             841
E                    Office            Marketing                       3,777
E                    Office            Telephone/Fax                1,606
E                    Office            Postage/Misc                     492
E                    Insurance    General Liability               1,119
E                    Insurance    Umbrella                              742
E                    Insurance    Property                               210
E                    Other            Taxes & Licenses            3,091
E                    Other            Prof. & Compliance        3,590
E                    Other            Travel/M&E                    1,205
E                    Other            Other                               1,437
                                                                            $1,906,164    $1,906,164

KEY TABLE
Key Symbol    Description
  A                     Assets
  L                      Liabilities
  C                     Equity (Capital Accounts)
  R                     Revenue
  COS               Cost of Sales (Costs of Construction)
  E                     Expenses

Key Business Principle

THE TOTALS IN THE TRIAL BALANCE FOR DEBITS AND CREDITS MUST BE EQUAL.  THIS SUMMATION VALUE DOES NOT APPEAR ANYWHERE ON THE FINANCIAL STATEMENTS.

Remember I stated earlier that the trial balance is an accountant’s tool.  But even as a bookkeeper you need to understand how to interpret the trial balance.

Analyzing The Trial Balance

If you look at the long list of accounts you should notice the preponderance of debit accounts over credit accounts.  This is because revenue is almost one line item and all the costs to generate revenue are broken out to reflect cost of sales and expenses.  This is normal in just about every business and industry.

Secondly you should easily identify the balance sheet types of accounts (located in the upper third) and income statement accounts in the lower two thirds.  The income statement starts with the revenue types of accounts.

Did you notice any contra or atypical accounts?

There are four.

In the assets section which are normally debit balances, accumulated depreciation as a credit balance.  You’ll see this in just about every trial balance for any business.

Over in the revenue section are two atypical accounts.  When a contractor closes on a house he pays commissions, legal fees, local tax fees and often incentives to get a contract signed.  In addition he’ll provide the buyer some allowances for items they bring to the deal such as appliances or personal work.  The net effect is the true value of the contract and is referred to as net sales.  Look at the financial statement illustration here:

Revenue
Contracted Construction               $1,393,742
Closing Costs                                     (67,411)
Allowances                                         (27,400)
    Net Sales                                    $1,298,931
Compliance                                            8,100
Interest                                                       207
Total Revenue                                $1,307,238

Notice how closing costs and allowances are debit balances and are in parenthesis in the revenue section – Lesson 14.  Also the lines of data follow the trial balance revenue lines of data.

The fourth atypical balance is in the equity section.  Distributions are payments to the shareholders for the profits earned.  This too is normal.

Now for the most important relationship issue.  Do you see a ‘Current Earnings’ account in the equity section?  You will never see this in a trial balance.  Why?

Well all debits and credits on the T/B are a function (sourced) from the journals – Lesson 3.  No journal has a ledger account available called ‘Current Earnings’.  Therefore it is impossible to post an entry directly to ‘Current Earnings’.

Current earnings is a fill in the blank as a function of the income statement.  To calculate the profit or loss year to date from a trial balance you simply add up all credits in the column from the revenue accounts through expenses including cost of sales.  From this you subtract all debits from the three income statement type of accounts (revenue, cost of sales and expenses).  If credits exceed debits there is a profit.  If debits are greater than credits than cost of sales and expenses exceed revenue and there is a lost.

Whether a profit (credit value) or a loss (debit value) it is reported on the balance sheet in the equity section.  Note that the balance sheet is not a trial balance.  Again ‘Current Earnings’ is never on the trial balance.

For a more comprehensive understanding read Lesson 9 about financial statement relationships.

My final note relates the T/B to the chart of accounts.  The difference between them is straight forward.  A T/B looks like a chart of accounts – Lesson 11, but it includes the account balances (debits and credits).

Summary 

The trial balance is an accountant’s tool that appears similar to a chart of accounts.  However it includes the ledger account balances at the requested date.  The T/B is organized by the six types of accounts, balance sheet types first followed by income statement types.

No matter what, total debits must equal total credits.  ACT ON KNOWLEDGE.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org.  I would love to hear from you.  If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.

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About David J Hoare (420 Articles)
I spent 12 Years as a Certified Public Accountant, Over 20 Years of Practice in Accounting and Consulting, Controller in Management of Closely Held Operations, Masters of Science in Accounting, Prepared over 1,000 Business Tax Returns and Hundreds of Individual Returns