Accounting practices are cumbersome to maintain for even the largest companies with sufficient capital to hire multiple accountants to scrutinize their records. The burden is even more onerous for small businesses and start-ups without enough funding to hire an expert. In situations like these, small business owners frequently undertake accounting efforts themselves. In either case, accuracy in accounting is paramount in furnishing a number of essential financial documents. Among these documents is the trial balance, a useful tool for accountants and entrepreneurs. Thus it's important to know. What is a trial balance?
An accountant or fearless small business owner creates a trial balance by compiling all a business's accounts and categorizing them as either income or an expense, as a credit or debit. This process enables the accountant to identify errors in the general ledger and modify the ledger as needed. Once the trial balance has been calculated accurately, it becomes a useful tool in compiling other financial documents such as a profit-and-loss statement or a balance sheet.
A trial balance synthesizes all of a business's credit and debit accounts and establishes whether the balances are equal, as they should be, or unequal, demonstrating a need for adjustment.
What Is a Trial Balance?
A trial balance is a comprehensive list of all a business's general ledger accounts, both credit, and debit. General ledger accounts are categories to which a business can ascribe either income or expenses. Any accounts representing income would be put in the right, credit column of the general ledger; any accounts reflecting an expense would be put in the left, debit column of the general ledger.
Credit accounts may include any loans held by a business, any retained stock, any retained revenue, accounts payable, and any long-term financial liability. Debit accounts may include wages or salaries paid, cash on hand, rent, utilities, and supplies. These two columns are added together separately to calculate the trial balance. In theory, the two columns should add to the same number.
Businesses typically maintain balance sheets, or sub-ledgers, for each account individually. Hence, while "wages paid" may appear in the debit column of the general ledger next to the total amount paid to all of a business's employees, there will be a more detailed sub-ledger maintained elsewhere that details exactly how much each employee was paid in any given interval.
Therefore, each account listed and the accompanying dollar amount on a trial balance and in the general ledger is confirmed by another ledger with a narrower scope. This structure allows the trial balance to present an amount of information that would be daunting to comprehend if presented in a more detailed fashion. A trial balance summarizes a business's fiscal intricacies in a singular, digestible format.
So, what is a trial balance, in terms of the actual, physical document? It is a document with two columns: one showing credit accounts and corresponding dollar amounts and the other showing debit accounts and corresponding dollar amounts. Each column will be added together, so, beneath each column will be a total of all the dollar amounts in that column. With any luck, the two numbers will match, and the accountant can move on to producing other documents using the trial balance as opposed to digging through the general ledger and the more intricate sub-ledgers.
What Is a Trial Balance in Terms of Importance?
A trial balance is used to ensure the credit and debit accounts are equal. If the totals of both columns match, the trial balance has verified the mathematical accuracy of all the accounts in the ledger and each of the individual sub-ledgers. It would be remiss not to note that a trial balance can be balanced without being entirely accurate, but this is a rare occurrence.
Typically, if the trial balance is correct, it is considered reflective of an appropriately prepared general ledger. If the column totals do not match, the trial balance indicates there is an error somewhere in the general ledger or in one of the sub-ledgers. In this way, the trial balance is the accountants first line of defense against a wide variety of potential errors. The most common accounting errors discovered upon completion of a trial balance are:
A totaling error has occurred when a simple addition error has compromised the accuracy of a column's sum. This type of error is easily corrected by recalculating each sum, preferably with a calculator in hand.
Error of Omission
When an account is missing from the general ledger, and hence the trial balance, an error of omission has occurred. To resolve an error of omission, the accountant must locate and include the absent account.
Transfer errors occur when accounts have been transcribed improperly; digits may be reversed or decimal points misplaced. The mistaken entry must be transferred to the correct column, and the sums recalculated.
An Error of Account Balance
If the account balance of a sub-ledger has been calculated incorrectly, an error of an account balance exists. The accountant must identify which account created the discrepancy and review it for accuracy.
Before a specific error has been identified and tracked down, what is a trial balance in terms of meaning if the column's respective sums are unequal? It is a red flag. Revisions are infuriating but the red flag an unbalanced trial balance represents should not be ignored as the implications are myriad.
Based on the information provided above, what is a trial balance in terms of significance? It is an important tool in determining if an error exists somewhere in the general ledger or within one of the sub-ledgers. If an error exists, the sums of the credit and debit columns do not match, and the accountant can begin working backward through the trial balance to find the error and take whatever steps are necessary to produce a suitably adjusted trial balance.
Furthermore, the less mathematically adept small business owner may find him or herself asking: what is the trial balance, balanced or unbalanced, in terms of importance relative to the infinite number of tasks commensurate with running a small business? Regardless of other operational concerns, the trial balance needs to be balanced to prevent a long-term misunderstanding of how a business works and what the margins are or worse, correspondence with the IRS.
What Is a Trial Balance Used For?
If the total of both columns is unequal, the trial balance enables the accountant to work back through the general ledger and find any of the potential errors identified above and adjust the general ledger as necessary. Once the columns add to the same sum, the trial balance can be used to create other useful financial documents or to track alterations in income and/or expenses over whichever interval the accountant chooses to analyze in greater detail. For example, an accountant may want to know how a business's costs change from the quarter to quarter.
In this case, the accountant can calculate a trial balance at the end of the third quarter (or a year, or month, etc.) and compare the trial balance to the trail balances calculated at the end of the first and second quarters. This analysis could show that utility costs spike in the winter when heating becomes a major expense or that wages increase in the summer when business is booming, and more employees are necessary.
In addition to parsing out errors and enabling swift comparisons, the trial balance is a helpful tool in creating other useful documents. Although it is not strictly necessary, a trial balance expedites the creation of a balance sheet which shows the total assets and liabilities of a business at a specific moment in time or a profit-and-loss statement which shows a business's revenue minus expenses over the course of any chosen interval. These documents may be used to demonstrate solvency when applying for a business loan, to complete tax returns, or to substantiate an income for a rental agreement.
In reference to the revision of accounting practices and production of financial documents for an array of uses, what is a trial balance used to accomplish? A trial balance is a great tool for finding and correcting problems in the general ledger or one of the sub-ledgers, as discussed in the previous section. Comparing the performance of a business within a given time frame to performance in a previous time frame, and substantiating business income or losses for tax purposes, loan application information, and/or rental agreements.
Conclusion: What Is a Trial Balance, Concisely?
The trial balance is a mechanism the astute accountant or business owner uses to find a wide variety of common accounting errors and subsequently produce other important documents for a variety of purposes. When the trial balance is unbalanced, when the totals of the respective columns do not match, the accountant can work backward to discover where the error occurred and rectify the discrepancy. When the totals come out to the same number, the accountant can create a profit-and-loss statement and a balance sheet among other helpful financial statements.