Trial Balances: Why a Common Practice is So Important
The preparation of trial balances is a common yet critical accounting practice performed by middle-market companies. Trial balances appear in a report run at the end of the reporting period (e.g., the month, quarter or year) that lists the ending balances in each general ledger account.
The purpose of preparing trial balances is to make sure that the totals of all debits and credits in the general ledger are equal and there are no unbalanced journal entries. Trial balances will ensure that a corresponding credit entry is recorded in the books for every debit entry that’s recorded, which is critical to ensuring accuracy in double-entry accounting.
The Trial Balance Worksheet
A trial balance worksheet will separate ledger balances into credit and debit balances. Asset and expense accounts will be listed on the debit side of the worksheet while liabilities, capital and income accounts will be listed on the credit side of the worksheet. Two trial balances are usually produced: an unadjusted trial balance and an adjusted trial balance (after any errors are corrected). Additionally, a post-closing trial balance may be produced after the end of the reporting period.
Preparing a trial balance worksheet usually consists of the following five steps:
- Close all ledger accounts at the end of the reporting period by adding up the debit and credit sides of the ledger to arrive at a closing balance.
- Post ledger balances into the trial balance.
- Cast the trial balance and look for any errors.
- Post corrective entries to rectify errors spotted.
- Incorporate any adjustments that haven’t been previously accounted for into the trial balance.
Your outside accountants will want to see both unadjusted and adjusted trial balances, along with the proposed adjustments. The numbers in the post-closing trial balance will be used in the preparation of annual financial statements. However, the trial balances themselves are strictly internal documents used by the accounting staff and auditors as a tool to help prepare accurate financial statements.
A year-end trial balance should be submitted to your outside accountants before they begin work on their preparation of a report on your financial statements. It may also be helpful to prepare trial balances at the end of each month or quarter to ensure that no mathematical errors have occurred during the entry of debits and credits into the accounting system.
Limitations of Trial Balances
It’s important to realize that just because debit and credit totals on a trial balance worksheet are equal doesn’t mean that there aren’t any errors in the accounting system. Trial balances can’t detect bookkeeping mistakes — they can only catch mathematical errors. So if a debit is entered in the wrong account or a transaction isn’t recorded at all, the debit total could be accurate and match the credit total while the balances in underlying accounts are wrong.
For example, suppose a supplier invoice for $500 is entered as a “supplies” expense and a $500 credit is added as an accounts payable liability. However, the expense should have been entered as an inventory purchase. The debit and credit sides of the ledger will still balance, but there will be inaccuracies in the underlying debit accounts.
Preparing trial balances is critical for many reasons other than creating accurate financial statements. For example, if trial balances don’t match due to irregular journal entries, you will be unable to obtain venture capital funding from an investment banker.
The preparation of trial balances is a common yet critical accounting practice performed by middle-market companies. Trial balances ensure that the totals of all debits and credits in the general ledger are equal and there are no unbalanced journal entries. However, just because debit and credit totals on a trial balance worksheet are equal doesn’t mean that there aren’t any errors in the accounting system — because trial balances can only catch mathematical errors, not bookkeeping mistakes. An outsourced CFO services provider can help you prepare accurate trial balances.
Arthur F. Rothberg, Managing Director, CFO Edge, LLC