0452 · 3.1The trial balance

Purpose and limits of trial balances

0:00Talia’s Stationery has matching debit and credit totals, yet a customer’s purchase has been recorded in the wrong account. Equal totals are useful evidence, but they are not proof that every record is correct. This video covers the purposes and limitations of a trial balance, its preparation and amendment, and six errors that leave its totals equal. Double entry means every transaction is recorded as a debit in one account and a credit of the same amount in another.

0:23A debit is an entry on the left side of an account, while a credit belongs on the right. Each transaction therefore adds equal amounts to opposite sides of the accounting records. That equality is the foundation of our check. A ledger is a collection of accounts, and an account balance is the difference between its debit and credit totals. A trial balance lists every ledger account balance at a date, with debit balances in one column and credit balances in the other.

0:47Its totals should agree. We use the balances remaining in the accounts, rather than copying every transaction. Imagine combining all the accounts into one large calculation. Because each transaction has equal entries on opposite sides, the combined debit and credit amounts should match. Extracting the remaining balances preserves that equality. However, this check compares amounts, not whether the correct accounts or transaction details were used. One purpose is to check the arithmetical accuracy of the double entry.

1:15The trial balance is also a starting point for preparing financial statements. Financial statements are summaries that show a business’s profit or loss for a period and what it owns and owes at a date. The list brings the account balances together before those summaries are prepared. Its main limitation is that it can balance even though errors exist. Equal totals do not establish that every transaction was recorded, correctly classified or entered in the right person’s account.

1:39A trial balance is therefore a useful numerical check, not a certificate of complete accuracy. Six types of error show this limitation, because each one leaves the debit and credit totals equal.

Classifying account balances

1:50To prepare a trial balance from a given list of balances, first identify the normal side of each account. Assets are resources owned or controlled by a business that bring future benefit, while liabilities are amounts it owes to others. Owner’s equity, also called capital, is the owner’s investment in the business, or the amount the business owes the owner. Asset balances normally belong in the debit column, whereas liabilities and capital normally belong in the credit column.

2:16Revenue is the income a business earns from its main activity, such as selling goods or providing services. Expenses are the costs used up in running the business and earning revenue during a period. Revenue normally has a credit balance, while expenses normally have debit balances. Each of these sides is the side on which an increase in that kind of account is recorded. Drawings are money or goods taken from the business by its owner for private use.

2:40They have a debit balance because they reduce owner’s equity. Profit for the year is the amount by which revenue exceeds expenses over one financial year. Drawings are not a business expense, so they never reduce the profit for the year. Purchases records the cost of goods bought for resale and normally has a debit balance. Goods sent back by customers are sales returns, which have a debit balance because they reduce sales revenue.

3:02When the business sends goods back to its suppliers, the purchases returns account records them with a credit balance. A bank overdraft is an amount owed to the bank, so its balance belongs in the credit column. Trade receivables are amounts owed by credit customers who have not yet paid for goods or services, so they are assets with debit balances. The credit balance on trade payables shows amounts owed to suppliers for goods or services bought on credit.

3:25Non-current assets are resources owned for continuing use in the business, rather than resale.

Preparing a trial balance

3:30Here are Talia’s balances on the thirty-first of May. Equipment is four thousand dollars, purchases are three thousand dollars, and rent is six hundred dollars. The list continues with drawings of five hundred dollars, sales returns of two hundred dollars and trade receivables of seventeen hundred dollars. Equipment is a non-current asset, rent is an expense, and all these balances belong in the debit column. The remaining balances are capital of five thousand dollars and sales of four thousand dollars.

3:57Trade payables are seven hundred dollars, purchases returns are one hundred dollars, and the bank overdraft is two hundred dollars. Sales represents this shop’s revenue, while trade payables and the overdraft are liabilities. Each of these balances belongs in the credit column. Write the business name, the title and the date above the two money columns. Enter each account balance once, on its appropriate side. Four thousand plus three thousand plus six hundred plus five hundred plus two hundred plus seventeen hundred equals ten thousand dollars.

4:26This is the debit total, not the value of the business’s assets. For the credit column, five thousand plus four thousand plus seven hundred plus one hundred plus two hundred equals ten thousand dollars. The debit total of ten thousand dollars equals the credit total of ten thousand dollars. Leave unused money cells blank, and check that every balance from the question appears exactly once.

Amending a trial balance

4:47We can also amend a trial balance which contains errors. Suppose someone copies the same balances but places drawings in the credit column and leaves out rent. The balances themselves are known, so this task is to repair their presentation. There is no need to create new transactions or change the original amounts. Without rent and drawings, the debit column adds four thousand plus three thousand plus two hundred plus seventeen hundred.

5:10That gives eight thousand nine hundred dollars. The five hundred dollars of drawings is on the wrong side. Rent of six hundred dollars is missing altogether, so two separate changes are needed. The incorrect credit total includes drawings as well as the five proper credit balances. Five thousand plus four thousand plus seven hundred plus one hundred plus two hundred plus five hundred gives ten thousand five hundred dollars. Move drawings into the debit column and restore rent there.

5:34Moving an item requires removing it from its original column as well as adding it to the correct one. Eight thousand nine hundred plus five hundred plus six hundred equals ten thousand dollars. On the other side, ten thousand five hundred minus five hundred also equals ten thousand dollars. The corrected debit total of ten thousand dollars equals the corrected credit total of ten thousand dollars. The amended trial balance therefore has the same rows and totals as the one prepared earlier.

Errors undetected by trial balances

6:01An error of commission records the correct amount on the correct side, but in the wrong account of the correct class. Suppose Talia sells goods on credit to Hannah for three hundred dollars. The correct entry debits Hannah’s account because her debt to the shop rises, and credits sales because revenue increases. Instead, the debit is posted by mistake to the account of another customer called Leila. Both Hannah and Leila are customers, so the mistake stays within the same type of account.

6:25The recorded debit of three hundred dollars still equals the credit of three hundred dollars. However, Leila appears to owe money for Hannah’s purchase. The numerical check cannot identify which customer actually bought the goods. An error of omission occurs when a transaction is not recorded at all. Talia buys goods for resale through the bank for eight hundred dollars, but neither entry is made. The correct treatment debits purchases because the cost of goods bought for resale rises, and credits bank because money held there decreases.

6:51Both sides are absent from the records. The missing debit is eight hundred dollars, and the missing credit is also eight hundred dollars. Leaving out equal amounts preserves agreement between the totals. This is a complete omission of the transaction, unlike leaving an existing ledger balance out when preparing the list. The trial balance cannot detect a transaction that never entered the records. A book of prime entry is where a transaction is first recorded from its source document before it is posted to the ledger.

7:17An error of original entry occurs when the wrong amount is entered in a book of prime entry and used for both entries. Talia’s credit sale to Marcus is twelve hundred dollars. It is initially recorded as two thousand one hundred dollars. Debit Marcus’s account because the customer’s debt rises, and credit sales because revenue increases. Those accounts and sides are appropriate, but both receive the incorrect amount. The recorded debit of two thousand one hundred dollars equals the recorded credit of two thousand one hundred dollars.

7:44Agreement checks the relationship between entries, not their accuracy against the source document. An error of complete reversal uses the correct accounts and amount, but reverses the debit and credit entries. Marcus pays nine hundred dollars through the bank. The correct entry debits bank because money held there rises, and credits Marcus’s account because his debt decreases. In the actual records, the sides are exchanged. The reversal makes the bank balance smaller and Marcus’s debt larger, although the payment should have the opposite effects.

8:13Nevertheless, the recorded debit of nine hundred dollars equals the recorded credit of nine hundred dollars. The correct accounts and amount alone are not enough. Their sides must also match what happened.

Principle, compensating errors and exam skills

8:24An error of principle records a transaction in the wrong class of account. Talia buys a new shop counter through the bank for fifteen hundred dollars. Debit equipment because the business acquires a non-current asset, and credit bank because money held there falls. Instead, the payment is wrongly debited to the repairs account, which is an expense account. The counter is for continuing use, so its purchase belongs in a non-current asset account.

8:46Treating it as a repair puts the amount in the wrong class. The recorded debit of fifteen hundred dollars still equals the credit of fifteen hundred dollars. Commission uses the wrong account within the correct class, whereas principle uses the wrong class altogether. Compensating errors are two or more mistakes whose effects on the trial balance cancel each other out. Suppose sales is overstated by four hundred dollars, while trade payables is understated by four hundred dollars.

9:10For the sale, debit the customer because their debt rises and credit sales because revenue increases. A credit purchase debits purchases because resale costs rise and credits the supplier because the amount owed increases. The debit entries are correctly recorded at sixteen hundred and eighteen hundred dollars. Sales is credited with two thousand dollars instead of sixteen hundred. The supplier receives a credit of fourteen hundred dollars instead of eighteen hundred.

9:34The extra four hundred dollars credited to sales cancels the four hundred dollars missing from the supplier’s account. Sixteen hundred plus eighteen hundred equals three thousand four hundred dollars. Two thousand plus fourteen hundred also equals three thousand four hundred dollars. Recorded debits therefore equal recorded credits, although two account amounts are wrong. Two errors are compensating only when their effects cancel exactly. In examinations, Paper One has forty multiple-choice questions, and Paper Two has five compulsory structured questions.

10:05Prepare means present information in a suitable format, so account names, columns and totals belong in your answer. Identify means name or select, while explain means give reasons why and how, supported by evidence. To name an error, compare the recorded accounts, amount and sides with the correct entry. Consider an exam-style question asking you to identify the error when a new counter is charged to repairs and explain its effect.

10:28The error is an error of principle. A non-current asset purchase has been recorded in an expense account. Equipment is understated and repairs are overstated, so the profit for the year is understated. The trial balance still agrees because an equal debit and credit have been recorded. Examiners reward answers that treat drawings as a reduction of owner’s equity and place a bank overdraft in the credit column. Keep commission for a wrong account within the correct class.

10:53Apply the correct categories before adding the columns. When amending a misplaced balance, remove it from one side and enter it on the other. When explaining agreement, state that equal debit and credit amounts remain despite the mistake. A trial balance checks the arithmetical accuracy of double entry and supplies balances for preparing financial statements. Prepare it from ledger balances, then amend misplaced or missing items before checking both totals.

11:17Commission, compensating, complete reversal, omission, original entry and principle can all leave those totals equal. Agreement confirms numerical equality, but the underlying records may still contain errors.