Bookkeeping – Trial Balance Advanced Concepts (Lesson 68)
The trial balance is a special report used by accountants and bookkeepers. It is NOT a management nor a financial report. Its primary purpose is verification of account balances and compliance to the dual entry system (debits equal credits). It is generally utilized as the first step in the closing process for interim and annual reporting. Experienced bookkeepers use the trial balance to spot egregious errors and obvious discrepancies. It is a tool that all bookkeepers need to be familiar with; including how to interpret the report and using it to spot anomalies.
This lesson introduces the bookkeeper to the report and its history. Another section explains its presentation format and the underlying basis of why it looks a certain way. Going one step further, I’ll explain how to spot obvious issues and finish up with some insights.
In preparation to this lesson, please read: Bookkeeping – Debits and Credits with the Trial Balance (Lesson 16).
Trial Balance Fundamentals
The report is basically three columns of information, the account name and two columns for values. One column is for debits and the other is for credits. The account’s balance is located in the appropriate column. Lessons 4 through 10 explain that each of the six account types customarily end with certain balances (debit or credit). Review the table below:
A basic trial balance will look like this:
April 30, 2016
Account Name DR CR
Fixed Assets 12,000.00
Accounts Payable 2,200.00
Long-Term Notes 3,100.00
Common Stock 1,000.00
Retained Earnings 5,950.00
Office Supplies 1,050.00
. $97,450.00 $97,450.00
If you look at the structure closely you will notice the following:
A) All six account types are represented in the report. In addition, their respective ending balances are in the appropriate columns.
B) Total debits equal credits as promulgated by the dual entry system.
C) The structure can be divided into the two primary reports of balance sheet and income statement. The accounts through retained earnings are balance sheet accounts and the remaining through the bottom half are income statement accounts.
D) There is NO current earnings account. Current earnings are simply the total credits less debits for the income statement accounts. Add them up and you’ll get a $750 credit balance in excess of debits. In effect there is a profit of $750 year to date. Lesson 9 explains the relationship of current earnings to the balance sheet and how it is reported.
E) Total debits and credits customarily exceed the revenue value. A common mistake by non accountants is the belief that this total debit or credit value is the net worth or revenue of the company.
F) The information is year to date and not month to date. An accountant can prepare a ‘Limited Version’ of just one month, but it requires understanding how current year to date earnings prior to the period are handled which is an advanced accounting issue. Suffice it to say that trial balances are rarely prepared for an interim accounting periods.
The report identifies the ending balances in the respective ledgers accounts. Historically, accounting was done with a set of books call ledgers and journals. Once the journals were balanced with equal debits and credits, it was time to verify that the ledgers were accurate. Remember lines of information were transferred to the ledgers after each entry in the journal was posted. Each ledger’s ending balance was then recorded to a trial balance and footed (added up) in the respective debit and credit column. If all data was entered correctly to the ledgers then the two value columns would equal each other. Often they didn’t and so the accountant would begin to review the trial balance for errors.
Modern day technology has eliminated the ability to post a one-sided or lopsided (one value greater or lesser than the other) entry. The trial balance with modern accounting software is pretty much fail safe in making sure all debits equal credits.
Now that the fundamentals have been explained along with the history behind the report; it is time to expand into the presentation formats used.
Presentation Formats of Trial Balances
To assist the reader with the trial balance, most reports include additional columns. Here is a list of additional information presented along with a short description.
Account Type – A letter code identifies which of the six account types the respective row of information belongs.
A = Assets
L = Liabilities
C = Equity (Capital)
R = Revenue
COS = Cost of Sales
E = Expenses
Account Group – Identifies the upper tier group of accounts such as:
Current Assets Fixed Assets Other Assets
Current Liabilities Long-Term Debt Equity
Sales Other Revenue Direct Costs
Indirect Costs Capital Expenses Other Expenses
Account Number – Read: Chart of Accounts Using the Numbering System (Lesson 18)
Sub-Account Group – More extensive chart of accounts break the account groups into sub groups. As an example, here is a manufacturing chart of accounts for current assets (account group); the sub-accounts and actual ledger accounts are outlined:
– Petty Cash
– Raw Materials
– Finished Goods
– Specialty Contracted Production
– Open Market
– Contracted Runs
– Limited Production
– Allowance for Doubtful Accounts
– Warranties and Maintenance
– Options on Raw Materials
– Contracted Amounts
Some accounting software will present the values for the respective sub-accounts as well as the individual ledgers (the actual accounts). What is important here is that the summation amount reflects the values from below in the actual accounts. In effect, it sums upwards instead of downwards as is customarily done in other reports. Look at the cash account presentation below:
Trial Balance (Limited Presentation)
May 31, 2016
Account Account Sub Account Ledger
Type Group Account Ledger Code ID # DR CR
A Current Cash P 1100 $79,202.17
A Current Cash Petty C 1101 647.19
A Current Cash Checking C 1111 43,983.42
A Current Cash Payroll C 1141 14,571.56
A Current Cash Reserves C 1181 20,000.00
A Current Inventory P 1200 243,742.83
P = Parent Account
C = Child Account
CO = Control Account
I = Internal Account
S = Suspense Account
Notice the cash account is a parent account and the debit value equals the sum of the child accounts underneath? Furthermore, the account codes indicate the various forms of accounts out there including an internal account which is explained in the advanced bookkeeping section of this website. Sometimes the account description is included as a column. I don’t recommend this as this information is included in the chart of accounts. Over time you will learn that with trial balances the only information you really need is the ledger name, account number and the associated ending values (debits or credits); basically the simpler the better.
Trial Balance Application
The primary purpose of the trial balance is confirm that the total debits and credits are in balance. This was explained thoroughly in Lesson 16. Modern day technology has eliminated this purpose. Now the trial balance is used to find obvious errors and act as a list of values to confirm. The following sections elaborate on these two purposes.
Obvious errors are focused on the ending balances of the respective account. Trial balance reports are similar to a balance sheet; it is a snapshot of a moment in time. The difference is that the trial balance is a list of all accounts including income statement accounts. Since there are six types of accounts, the ending balances should associate with that type of account as follows:
Account Type Ending Balance
As explained in Lesson 12, contra accounts exist in all types of accounts and will have offsetting (opposite) ending balances. The following is a list of common contra accounts and their respective type of account and ending balance.
Account Type Sub-Group Contra Account Ending Balance
Assets Current Payroll Prep Credit
Assets Current Reserve for Uncollectible A/R Credit
Assets Fixed Accumulated Depreciation Credit
Assets Other Amortization Credit
Liabilities Long-Term Debt Principle Payments Debit
Equity Common Stock Treasury Stock Debit
Equity Retained Earnings Distributions/Dividends Debit
Revenue Sales Discounts Debit
Revenue Sales Returns Debit
Revenue Sales Allowances Debit
Cost of Sales Materials Returns Credit
Expenses Cost of Capital Discounts Credit
In addition to contra accounts, it is possible, though uncommon, for suspense accounts to have offsetting (opposite) balances. Other than proper ending balances, obvious errors include:
A) An account with the wrong account type assigned. For example a cash account is never located in liabilities or in the income statement sections.
B) An ending balance that is obviously lopsided or wayward in value. For this to happen, another account will have an unreasonable opposite ending balance.
C) Unexpected or unreasonable ending balances in the respective account may exist.
In small business, bank fees should never exceed $9,999; five digits for bank fees in small business is highly questionable.
The overall purpose is to ensure good organization with the account structure and confirming that the ending account balances are within tolerances.
The final purpose of the trial balance is its application in balancing the books, i.e. getting the books correct. It is simply a methodical account by account verification of the balance. The trial balance works like a check off list.
1) Cash accounts are verified against bank statements and physical counts of register tills or petty cash;
2) Inventory is vouched against actual (physical) counts;
3) Accounts receivable is managed per a program of communication and risk reduction;
4) Fixed assets and depreciation are confirmed against schedules with visual confirmation of existence;
5) Amortization is also vouched against schedules;
6) Liabilities are compared against vendor statements and confirmation with lenders;
7) Projects and revenue are traced and physically confirmed via inspections;
8) Costs are monitored and tested by comparing them against historical standards. In addition, costs are verified via payroll and time sheets;
9) Payroll is reviewed for errors and balanced against governmental reports; AND
10) Expenses are tested for reasonableness.
This confirmation process is also a part of the interim and year-end closing procedure covered in Lesson 69.
The trial balance is preset as one of the accountant’s reports in the reporting section of the accounting software. I typically pull the report weekly to review progress and look for errors. One of the tricks I learned is to limit the transaction range to the particular accounting period currently in operation. The balance sheet accounts include carry forward balances and the income statement accounts are limited to that accounting period (month).
If you don’t limit the transaction period, the trial balance reflects year to date information in the income statement accounts. Remember, all income statement accounts reset to zero at the beginning of the fiscal year (for most small businesses the fiscal year and calendar year are the same).
Most small businesses will have less than 100 accounts with the books of record. Over time you will begin to expect certain values in each account so spotting obvious errors gets easier with experience.
Summary – Trial Balance
The trial balance is used by accountants and bookkeepers to verify account balances and identify obvious errors. Historically, it was used to confirm the dual entry bookkeeping concept. Modern day technology has eliminated this purpose. Today the report is used to spot inappropriate ending balances and egregious errors. Experienced bookkeepers will use the trial balance as a check off list during confirmation of balances with the closing process. ACT ON KNOWLEDGE.
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