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

A list of accounts and their corresponding ending values is called a trial balance. The trial balance must have all aggregated debits and credits equal.

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. Some insight into interpreting the trial balance is covered. Finally, it is explained why there is no ‘Current Earnings’ line on the trial balance (T/B). From this point the short hand of T/B is used 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. This is explained this in detail in Lessons 4 through 8 and in Lesson 10. If you need a refresher, please review the following lessons for 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 Bookkeeping Principle

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

 

 

 

 

It can’t be emphasized 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, let’s 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 Rcvb                   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 the debits and credits were not summed up? If they were, they would not be equal. This is because this is just one subsection of the entire trial balance. Your debits and credits must be equal for the entire trial balance.

One more little note, when addressing contra accounts, prior lessons 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 Rcvb                            53,200
A                    CA                       Prepaid Insurance                       14,102
A                    Fixed                   Site Equipment                           35,413
A                    Fixed                   Transportation                            51,775
A                    Fixed                   Accumulated Deprec                                                 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 Mgmnt                            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 Bookkeeping 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, it was 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 is one. 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 loss.

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.

A 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 – Debits and Credits with the Trial Balance

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.

Please follow and like us:
Follow by Email
LinkedIn
Share