What is a Trial Balance? Types, Benefits, Steps, and Limitations Explained

 

What is a Trial Balance?

The core of any business is the trial balance. It provides an overview of the company's operations.  It also serves as a gauge for the company's financial stability. In essence, it is an overview of every debit and credit made to a business's accounts at a particular moment in time, usually the conclusion of a fiscal year. All of the figures in your business's financial records for a specific period are summarized in a trial balance. 

By calculating the totals of all general ledger accounts, including assets, liabilities, expenses, income, and equity, and dividing them into two columns—credit or debit, depending on the transactions coming into and going out of each account—it serves as an internal audit for double-entry accounting systems.

Also read: What Is Cost Accounting? Types, Importance, and Limitations Explained

What kinds of Trial Balances are there?

Trial balance comes in three primary varieties.  Despite having the same structure, they are employed in quite distinct situations:

1. The Trial Balance Without Adjustments

Before any correcting entries are made, the balances of all general ledger accounts are summarized in a financial statement known as the unadjusted trial balance. It serves as a log of daily transactions that can be utilized to correct journal entries and balance your ledger. To make sure the ledger is balanced and to find any disparities that require modifying entries, the unadjusted trial balance is utilized.

2. Adjusted trial balance 

Official financial statements can be prepared using an adjusted trial balance when your finances are balanced.  After deferrals, accruals, and other required changes are taken into consideration, it shows the company's financial situation is shown. To create correct financial statements, including the income statement and balance sheet, the adjusted trial balance is necessary. The basis for creating financial statements, such as income and balance sheets, is the more accurate adjusted trial balance.

3. The Post-Closing Trial Balance

A financial statement known as the post-closing trial balance shows the balances of every general ledger account following closing entries. Only permanent accounts, such as equity, liabilities, and assets, are included, guaranteeing that the ledger is prepared for the following accounting period. After the accounting period, after all closing entries have been completed, the post-close trial balance is usually prepared. For the upcoming fiscal year, it serves as the initial trial balance. 

Benefits of a Trial Balance

1. Recognizing Mistakes

 The ability to detect inaccuracies in accounting data is one of the trial balance's main benefits. There is a mistake in the records if the total debits and credits do not equal one another. Early error detection allows the business to make necessary corrections before they have a chance to seriously harm the company. 

2. Arithmetic accuracy: 

Due to the double-entry system's design, each transaction will produce two entries that are opposing in nature and of equal value.  As a result, the totals of the debit and credit ledgers will always be equal. The trial balance's aforementioned benefit is largely irrelevant when accounting software is used.

3. Conserves Time and Energy

A summary of the ledger balances is provided by the trial balance, which saves time and effort.  To verify that the balances are correct in the absence of a trial balance, accountants would need to review every account in the ledger. This is a laborious process that is prone to mistakes.

How Do Trial Balances Operate?

 Listing all of the ledger account balances in two columns—debits and credits—is how a trial balance is calculated.

Step 1: General Ledger Compilation

 Businesses need to carefully compile all of their general ledger accounts before preparing a trial balance. All ledger account balances are compiled at the conclusion of a reporting period.  Various financial operations, such as revenue, expenses, assets, and obligations, are included in this repository.

Step 2: Listing of Credits and Debits

Every ledger balance is recorded in the corresponding credit or debit column of the trial balance worksheet. Debits are used sparingly to document increases in assets and costs. To preserve the financial integrity of the company, these transactions must be linked to the corresponding debit or credit attributes.

Step 3: Entering Balances in Accounts 

 Before continuing, it is crucial to note each account's balance—whether it is credit or debit—in the corresponding column. Each ledger account's name is listed in one column, and its debit and credit amounts are listed in the other two.  It is optional to include account numbers and other information.  

Step 4: Equilibrium Verification

According to the fundamental tenet of double-entry accounting, there must be an equal and equivalent credit for every recorded debit. This is fundamental to maintaining the financial balance of a company's accounts. When properly maintained, a balanced set of books should always show that the total number of debits and credits is equal.

Step 5: Getting the Trial Balance Ready

When the ledger accounts are harmonized and the total of the debits equals the total of the credits, a balanced trial balance is produced.  You must locate the mistake in your ledger if they are not equal.  It may be simpler to find and fix frequent mistakes that result in unbalanced credit and debit columns if you are aware of them.  Only after all mistakes have been fixed may you close the account.

Constraints of a Trial Balance

1. Inappropriate Use of Amounts

 When accurate sums are entered under incorrect accounting categories, the trial balance is unable to detect the problem. Entry misclassifications may still produce a balanced trial balance, which would obscure these allocation errors. 

2. It cannot guarantee the accuracy and dependability of the ledger.

 Errors may still occur in the ledger even if this statement balances because of mistakes made during the balancing procedure or when publishing transactions. For instance, this statement will still appear balanced even if amounts are entered improperly or if entries are left out. Consequently, even while this statement is helpful, it shouldn't be the only reason used to determine the accuracy of the financial records.

Also Read: What is GAAP? Principles, Importance, and Why It Matters in Financial Reporting

In Conclusion

A trial balance is a basic accounting instrument that summarizes all debits and credits to guarantee the correctness of a company's financial records. By providing a consolidated view of ledger balances, it supports mathematical correctness, helps identify errors, and saves time. Notwithstanding its benefits, it has drawbacks. 

For example, it is unable to identify all problems, including missing data or wrong account classification. Nonetheless, companies can keep accurate and well-organized financial data by knowing the many kinds of trial balances and how they work.  Finally, before creating proper financial statements, a trial balance acts as an initial inspection.