If you’re lost in the world of financial accounting, consider the trial balance as the soul of your accounting system. Every journal entry or transaction flows into the trial balance, but how do these entries get there? Jean Scheid explains preparing a trial balance.
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What is a Trial Balance?
Just when you think you finally understand your income and expense statement and your balance sheet, here comes another accounting tool, the trial balance. Think of the trial balance as the place where every transaction eventually ends up in the form of a debit or credit. But how do you prepare a trial balance?
A trial balance is probably the accounting tool that accounting professionals request most when preparing your company’s tax return. To the layperson, you may wonder why it’s even important especially because your income and expense statement or profit and loss statement already reveals your financial numbers?
Click on the image to the right to see an example of a trial balance for an auto body and paint shop. While this doesn’t show every account on the trial balance, it gives you a general idea of what is revealed in the trial balance:
Account Name – These account names are pulled from the chart of accounts.
Account Number – In this example, it shows sales accounts, which usually begin in the 400 number range.
Debits – The debits here, say in “paint material sales," show $1,147.08. This number is pulled from your general ledger as you make typical journal entries throughout the month for paint material sales. Keep in mind that in a trial balance, in sales accounts a debit decreases your ending balance.
Credits – The credits here in “paint material sales," show $39,269.97, also made from the entries you make in your general ledger throughout any given month. Keep in mind here that credits to sales accounts in a trial balance mean an increase or a positive number.
Change – The change column represents your total debits and credits.
Ending Balance – Here the ending balances are zero. If your debits did not equal your credits, a number would appear here and would have to be explored to find the discrepancies, usually found in your general ledger, journal or schedule detail.
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Tips to Prepare a Trial Balance
In most accounting software systems such as Quickbooks or Quicken, the trial balance is automatically set up through your chart of accounts. A chart of accounts is a listing of every account for your business, including assets, sales, cost of sales, expenses, and liabilities.
In essence, if you utilize an accounting software program, such as the one shown in our example, as you make journal entries in your general ledger throughout the month, all of your debits and credits pull to the trial balance. In some accounting software systems, there may be an option to “create a trial balance" for the specified period.
Accounting software looks at all the journal entries, regardless of where they are posted (general ledger, journals or schedules) and places them in the appropriate accounts in the trial balance based on the posting detail. But what if you had to prepare a trial balance on your own? First, download and print the Trial Balance Template found in our Media Gallery.
This MS Excel trial balance document automatically calculates from the numbers you enter. Once you’ve downloaded the Excel trial balance, you will see that our debits and credits do not equal and there is a difference of ($10,000) on the credit side. If the “difference" is not zero, you need to find the error in your accounting books.
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Finding Trial Balance Errors
To see the trial balance, look at the Trial Balance Template you downloaded from the Media Gallery. Here, if you scroll to the bottom, our trial balance is off by ($10,000) with debits of $50,000 and credits of $60,000. Let’s look at the detail on the trial balance:
Cash in Bank – A debit of $10,000
Revenues – A credit of $10,000
Sales - A credit of $50,000
Cost of Goods Sold Materials – A debit of $25,000
Cost of Goods Sold Labor – A debit of $15,000
Here the credits are $60,000 and our debits are $50,000 making the trial balance off balance by ($10,000). Where do you go from here to find out why the trial balance debits and credits do not equal?
In most accounting software programs, while you’re in the trial balance function, there is an option to “drill down," accounts that will give you an in-depth look at the entire detail posted from your general ledger to see where those debits and credits came from.
Through investigation of our journal entries, we might find the following:
Cash in Bank – A debit of $10,000 – This is the amount deposited into our bank account from our Revenue account.
Revenues – A credit of $10,000 meaning the company made $10,000 from sales of $50,000 for the month. Through the drill down process, we would see journal entries showing where the revenues of $10,000 came from: Sales of $50,000 less cost of goods material and labor (-$25,000) – (-$15,000) leaving company revenues of $10,000 which is deposited into the cash in bank account.
Sales – A credit of $50,000 showing the company had $50,000 in sales for the month. A drill down of the sales account here would show every sale the company made during the month.
Cost of Goods Sold Materials – A debit of $25,000 meaning of the $50,000 in sales, the company had to pay $25,000 for materials. Looking at this account, it would show the materials that had to be purchased from vendors to complete the sales.
Cost of Goods Sold Labor – A debit of $15,000 meaning of the $50,000 in sales, the company had to charged $15,000 in labor costs. A drill down here would show how the $15,000 labor charges that were debited to each sale and charged to each customer.
What’s missing here that makes our trial balance unbalanced is while we had a credit for cost of labor of $15,000. Of that $15,000, we paid employees $10,000 which does not appear in our payroll expense account as a debit. Once the $10,000 payroll is posted to the general ledger or payroll journal and the trial balance is recalculated, the debits and credits are equal.
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Why the Trial Balance is Necessary
Once calculated, if all the debits and credits in your trial balance equal, then your financial books are mathematically correct for the accounting period whether it is for a month or an entire year.
Preparing a trial balance comes from the journal entries made into your ledgers, journals, or schedules. If at the end of any accounting period, you see a discrepancy, you will have to analyze or “drill down" accounts to see the journal postings to determine the discrepancy, make the appropriate adjustments, and then re-run your trial balance or an adjusted trial balance.
When the debits and credits are off or not equal, it means something is not posted in your general ledger or posted incorrectly, perhaps a debit was posted as a credit, for example. Through analysis of the summary totals in the trial balance, corrections can be made to ensure your financial books are accurate before the data is transferred to your income and expense statement and ultimately, your balance sheet.