One of the main concepts that underlies accounting practices is balance. While you might see individual ledger accounts go up and down, it’s up to the accountant (or the accounting software) to make sure all of them balance—and a trial balance shows just that. Usually generated every accounting period, the balance helps identify errors in the ledger accounts before the balance sheet and other financial statements are prepared. In the days of manual accounting, trial balances were vital to help identify mathematical errors that made debits and credits unbalanced. If you’re using accounting software, your debits and credits will always match, but understanding how these balances work can still help you spot errors in your records before they go on your balance sheet.
- What is a Trial Balance?
- How to Prepare a Trial Balance
- What is the Difference Between Trial Balances and Balance Sheets?
- What is the Difference Between Unadjusted Trial Balances and Adjusted Trial Balances?
- The Trial Balance Today
What is a Trial Balance?
A trial balance is a list of every ledger account that has an amount in it, and its balance. If you’re a little familiar with accounting already, you may know that all ledger accounts fall into one of two categories: debit accounts that increase with debits, and credit accounts that increase with credits. Whether or not an account is a debit or a credit account depends on what side of the accounting equation they fall under:
Assets = Liability + Equity
Since everything your business owns must be equal to everything you have put into it and everything you owe, all the ledger accounts on one side of the equation must match the ledger accounts on the other. For example, if you take out a £10,000 loan, you have £10,000 in liabilities and £10,000 in cash assets. If you were keeping track of your books manually and missed a zero on one of the accounts, your trial balance would show that the two don’t match, and you could correct the error. Trial balances are used to prepare balance sheets and other financial statements as well and are an important document for auditors.
How to Prepare a Trial Balance
Usually, a trial balance will have your company name, the title of the report, and the date it was prepared at the top. Then, every account would be listed with its account number and name on the right, and the balance in either the debit or credit column. Usually, the account names are listed by type, starting with assets, then liabilities, equity, revenue, and expense accounts. At the bottom of the trial balance sheet, the total credits and total debits are listed in their respective columns—and they should be the same.
What is the Difference Between Trial Balances and Balance Sheets?
A trial balance is meant to be an internal document, used only to double-check the accuracy of all of your ledger accounts. A balance sheet, on the other hand, is more of a formal summary, a snapshot of the total value of a business at any given point in time. A balance sheet might be prepared for investors, but a trial balance isn’t usually a document shown to anyone outside the business, since there’s a lot of detail, but not a lot of significant totals. It’s not a good overview of any particular financial behaviour and doesn’t give the viewer an accurate total of the value of a business, but it does help as a first step in preparing these higher-level reports.
The balance sheet in particular seems deceptively similar to the trial balance, since it too shows in part that the ledger accounts balance—but they are very different reports! One of the key differences between a trial balance and a balance sheet is that the former lists all accounts, both temporary and permanent, while the latter lists only permanent accounts. The accounts on the balance sheet are all accounts that accumulate over time, while some accounts—revenue and expenses, for example—get closed out at the end of each accounting period, and their amount is transferred into other accounts. This means that the total debits and credits on your trial balance will be different than the total debits and credits on your balance sheet. It’s not an error, it’s just that some of the amounts in the temporary accounts are also amounts in permanent accounts before they are closed out.
What is the Difference Between Unadjusted Trial Balances and Adjusted Trial Balances?
The unadjusted trial balance is generated before any month-end adjustments are made to the accounts. It’s just there to help the accountant doing manual accounting to know whether or not the debits and credits match, and as a review of all the accounts for an accountant using software.
Usually there are some significant adjustments to be made, especially in accrual accounting, where revenues and expenses are recorded when they are issued rather than when money changes hands. So bills which have been sent to clients but haven’t been paid yet need to be recorded, as well as things bought on credit. There are also often adjustments like depreciation, which happen automatically but don’t have an equivalent physical transaction, and automatic debits that come out of a business bank account that have yet to be recorded. It’s usually only after doing a bank reconciliation that these transactions are all captured in the books.
The adjusted trial balance is the new balance after all the adjustments are made and represents the final amount of the accounts that will go into preparing the income statement, balance sheet, and other financial reports.
The Trial Balance Today
Accounting software like Billomat will automatically post balanced accounting entries every time, meaning trial balances don’t have the same significance they once used to. If you’re using software for accounting, you may not need to check your math, but you can still check your trial balance as a review of all the ledger accounts before and after any adjustments are made. Since the amount listed under each account is a summary, the trial balance won’t necessarily tell you whether or not you’ve made a typo—but it’s good to check over, since it makes it easy to review all the accounts to make sure they seem about right. If one of your accounts seems way off, it’s a sign you need to investigate!
The adjusted trial balance will also give you the nuts-and-bolts breakdown of your ledger accounts, so if you want to compare a few specific accounts over time, the balance makes them easy to find. When final financial statements can leave you with questions about accounts that aren’t listed on them, the adjusted trial balance is there to help you answer them.