What is a Trial Balance?

1. Purpose of Trial Balance 2. Example of Trial Balance 3. Limitations of Trial Balance

Trial Balance is a list of closing balances of ledger accounts on a certain date and is the first step towards the preparation of financial statements. It is usually prepared at the end of an accounting period to assist in the drafting of financial statements. Ledger balances are segregated into debit balances and credit balances. Asset and expense accounts appear on the debit side of the trial balance whereas liabilities, capital and income accounts appear on the credit side. If all accounting entries are recorded correctly and all the ledger balances are accurately extracted, the total of all debit balances appearing in the trial balance must equal to the sum of all credit balances.

Purpose of a Trial Balance

Trial Balance acts as the first step in the preparation of financial statements. It is a working paper that accountants use as a basis while preparing financial statements. Trial balance ensures that for e er! "ebit entr! recor"e"# a correspon"ing cre"it entr! has been recor"e" in the books in accor"ance with the "ouble entr! concept of accounting. If the totals of the trial balance "o not agree# the "ifferences ma! be in estigate" an" resol e" before financial statements are prepare". $ectif!ing basic accounting errors can be a much length! task after the financial statements ha e been prepare" because of the changes that woul" be re%uire" to correct the financial statements. Trial balance ensures that the account balances are accuratel! extracte" from accounting le"gers. Trail balance assists in the i"entification an" rectification of errors.

Example
Following is an example of what a simple Trial Balance loo s li e!
ABC LTD Trial Balance as at 31 December 2011 &ccount Title 'ebit (re"it ) )

*hare (apital -urniture . -ixture Buil"ing (re"itor 'ebtors (ash *ales (ost of sales 0eneral an" &"ministration Expense Total

1+#,, , +#,,, 1,#,, , +#,,, 3#,,, 2#,,, 1,#,, , /#,,, 2#,,, 3,#,, 3,#,, , ,

Title pro i"e" at the top shows the name of the entit! an" accounting perio" en" for which the trial balance has been prepare". &ccount Title shows the name of the accounting le"gers from which the balances ha e been extracte". Balances relating to assets an" expenses are presente" in the left column 1"ebit si"e2 whereas those relating to liabilities# income an" e%uit! are shown on the right column 1cre"it si"e2. The sum of all "ebit an" cre"it balances are shown at the bottom of their respecti e columns.

Limitations of a trial balance

Trial Balance only confirms that the total of all debit balances match the total of all credit balances. Trial balance totals may agree in spite of errors. An example would be an incorrect debit entry being offset by an equal credit entry. Li ewise, a trial balance gi"es no proof that certain transactions ha"e not been recorded at all because in such case, both debit and credit sides of a transaction would be omitted causing the trial balance totals to still agree. Types of accounting errors and their effect on trial balance are more fully discussed in the section on #uspense Accounts.

Depreciation

$epreciation is systematic allocation the cost of a fixed asset o"er its useful life. It is a way of matching the cost of a fixed asset with the re"enue %or other economic benefits& it generates o"er its useful life. 'ithout depreciation accounting, the entire cost of a fixed asset will be recogni(ed in the year of purchase. This will gi"e a misleading "iew of the profitability of the entity. The obser"ation may be explained by way of an example.

Example
AB) LT$ purchased a machine costing *+,,, on +st -anuary .,,+. It had a useful life of three years o"er which it generated annual sales of */,,. AB) LT$0s annual costs during the three years were *1,,.
If &B( LT' expense" the entire cost of the fixe" asset in the !ear of purchase# its income statement woul" present the following picture the en" of the three !ears3

Income Statement .,,+ .,,. .,,1 * #ales )ost of #ales Fixed Asset )ost Net Profit (Loss) /,, * /,, * /,,

%1,,& %1,,& %1,,& %+,,,& %3,,& 2 3,, 2 3,,

As you can see, income statement of AB) LT$ shows net loss in the first year e"en though it earned the same re"enue as in the subsequent years. )on"ersely, no fixed asset will appear in AB) LT$0s balance sheet although it had earned re"enue from the machine0s use through out its useful life of 1 years.
If &B( LT'# instea" of charging the entire cost of fixe" asset at once# "epreciates the capital expen"iture o er its useful life# its income statement an" balance sheet woul" present the following picture at the en" of the three !ears3

Income Statement .,,+ * #ales /,,

.,,. * /,,

.,,1 * /,,

)ost of #ales Fixed Asset )ost Net Profit (Loss)

%1,,&

%1,,&

%1,,&

%111.1& %111.1& %111.1& +44.5 +44.5 +44.5 .,,. * .,,1 *

Balance Sheet (Extract) .,,+ * Fixed Assets

+,,,, +,,,, +,,,,

Accumulated $epreciation %111.1& %444.5& %+,,,,& Net Boo !alue 444.5 111.1 6ill

As you can see, the process of relating cost of a fixed asset to the years in which the economic benefits from its use are reali(ed creates a more balanced "iew of the profitability of the company. 7ence, depreciation is an application of the matching principle whereby costs are matched to the accounting periods to which they relate rather than on the basis of payment.

"ccountin# Entr$
$ouble entry in"ol"ed in recoding depreciation may be summari(ed as follows! $ebit )redit $epreciation 8xpense %Income #tatement& Accumulated $epreciation %Balance #heet&

8"ery accounting period, depreciation of asset charged during the year is credited to the Accumulated $epreciation account until the asset is disposed. Accumulated depreciation is subtracted from the asset0s cost to arri"e at the net boo "alue that appears on the face of the balance sheet. 9sing the last example, following double entries will be recorded in respect of depreciation! $epreciation 8xpense Account $ebit * )redit * .,,+ Accumulated $epreciation 111.1 .,,+ Income #tatement 111.1 .,,. Accumulated $epreciation 111.1 .,,. Income #tatement 111.1 .,,1 Accumulated $epreciation 111.: .,,1 Income #tatement 111.: Accumulated $epreciation Account $ebit * )redit *

.,,+ Balance c;d 111.1 .,,+ $epreciation 8xpense 111.1 111.1 111.1 .,,. Balance c;d 444.4 .,,. Balance b;d 111.1 .,,. $epreciation 8xpense 111.1 444.4 444.4 .,,1 Balance c;d +,,, .,,1 Balance b;d 444.4 .,,1 $epreciation 8xpense 111.: +,,, +,,,