What is a Trial Balance?

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Definition:

A trial balance is a first step in closing a company’s financial books for a month by ensuring that credits and debits are equal.

🤔 Understanding trial balances

A trial balance is a quick accuracy check of a company’s finances. Because every credit entry to a company’s account must have an offsetting debit entry elsewhere, the total credits from all ledger accounts must equal the total debits from all accounts. A trial balance moves all credits and debits into one spreadsheet so that someone can confirm that everything lines up. With modern accounting software, many companies have built-in protection against bookkeeping errors and a system that generates automatic trial balances. Therefore, the practice of completing a manual trial balance is less common in business today.

Example

Imagine that during the month a company purchased a new copy machine for $10,000. As soon as the purchase clears, the company’s cash account is reduced by the $10,000 purchase. When the accountant enters the new equipment into the asset account, they accidentally record the value of the copier as $11,000. This error would be caught on the trial balance. When all of the accounts are lined up, you will see that the total credit balance is $1,000 off from the total debit balance. From there, it’s just a matter of tracking down the error.

Takeaway

A trial balance is like a dress rehearsal…

When you are getting ready for a big event, like a wedding or award ceremony, you will probably put a lot of time into planning every detail. No matter how much attention you put into the schedule, there are bound to be issues you didn’t think about. By running through the program (lining up the account balances) before the audience arrives (you close the books), you can spot any problems that you didn’t consider when everything was just on paper (held in separate accounting records).

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What is a trial balance?

A trial balance is an internal document used by the accounting team, management, and auditors. It is not part of the company’s public financial disclosures. Instead, it serves as the first step in closing the company’s books for the accounting period. Once the trial balance shows equal credits and debits, the accounting team can use it to prepare the official financial statements.

What are debits and credits in a trial balance?

In accounting, every transaction requires both a credit and a debit to different accounts. This process is called double-entry accounting. Each account represents something that is owned (asset) or something that is owed (liability). Standard general ledger accounts include:

  • Assets
  • Liabilities
  • Stockholder Equity
  • Income
  • Expense
  • Gains
  • Losses

A company can have just a handful of accounts, or it can have hundreds. It just depends on the complexity of the business operations. Every time a company takes any financial action, it gets recorded as a debit and a credit to the corresponding accounts. For example, if the company borrows $500 from the bank, it records an accounting entry to the cash account and the liability account.

The confusion about credits and debits is that they don’t always mean what you think they do. For instance, notice that the previous example increases the company’s cash and also increases the amount it owes. But increases cannot mean that you credit each account. You must credit one and debit the other.

So, in this example of borrowing money, you credit accounts payable (liability account). And, although it is counterintuitive, you have to debit the cash account (an asset).

When the trial balance is prepared, all of the debits and credits from each account are tallied. Then the sum of the account activity gets placed in the debit or credit column for each account.

What is the purpose of the trial balance?

Accountants prepare a trial balance at the end of an accounting period. It is the first step in closing the books for the month, quarter, or year. Once the records are closed, no more entries can be made. At that point, the accounting team will begin preparing the financial disclosures for the company. Locating an error in the middle of putting the financial statements together can cause a significant headache. It might even require starting the process over. So the purpose of a trial balance is to catch any obvious problems before putting too much effort into the process.

Auditors also require a trial balance at the beginning of an audit. The purpose of the trial balance, in that case, is to get a good overview of the ledger accounts. From there, the auditor can start their exploration into the records and make sure that everything evens out the way it is supposed to.

How does a trial balance work?

A trial balance is a snapshot of the company's finances. It moves the activity from all of the subledger accounts into a general ledger. Next to each account name, the sum of all the credits or debits made during the accounting cycle is listed. This number should be equal to the difference in the account total between the beginning and the end of the period.

Once all of the accounts and values are complete, you add up the total in each column. If the numbers are different, you immediately know that something is wrong. Perhaps there is a data entry error. Or maybe depreciation wasn’t accounted for yet. There could be any number of reasons that the numbers don’t balance, but that is what the trial balance is for — At that point, the accounting team can locate the problem.

It’s also worth pointing out that just because the numbers do balance, that does not mean the books are perfect. A trial balance only flags the fact that the accounts are out of balance. It doesn’t catch any other types of errors.

What is the difference between a trial balance and a balance sheet?

The most significant difference between a trial balance and a balance sheet is the target audience. A trial balance is created as an internal document that rarely leaves the accounting team. A balance sheet is part of the documents that make up a company’s financial disclosure. It is intended as an external document for all the world to see.

A trial balance lists all of the company accounts, along with the balance of credits and debits for each. Accountants use it as they prepare the balance sheet and other financial documents. A balance sheet, on the other hand, contains all of the company assets and liabilities, which provides investors with an understanding of the company’s financial strength.

What are the requirements for a trial balance?

A trial balance requires access to all of the company’s finances. With the total debit and credits values for all accounts, it’s just a matter of putting them in one place. From there, the only requirement is that the debits and credits are equal. If not, you have an error to find. But a trial balance is not part of the company’s official financial record.

How do you prepare a trial balance?

Most digital accounting systems will track your entries for you. A trial balance is always available at the touch of a button, and it gets updated with each entry you make. If you want to prepare a trial balance by hand, you need to collect the information from all of the accounts. First, create a table with three columns. Title the left-hand column “account name,” the middle column “debits,” and the right-hand column “credits.”

Use the company’s chart of accounts to locate all of the account names and list them in the first column of the trial balance. Accounts are often ordered by account number, which would be an optional fourth column to the left of the account names. Next, go to each account and add up all of the debits and credits during the accounting period. Subtract the smaller number from the larger number and place the remainder in the appropriate column on the trial balance.

For example, if the cash account had a total of $10,000 in debits and $8,000 in credits, you would put $2,000 in the debits column. Once you have a value assigned to every account, total the credit column and the debit column at the bottom of the trial balance. That’s it. If the totals at the bottom are the same, your trial balance shows that you don’t have any out-of-balance errors.

Next, an accountant will develop an adjusted trial balance. Adjusting journal entries aligns expenditures and revenues with the correct accounting period. They are required whenever an invoice or payment doesn't come in the same month that it was incurred. Once the adjusted trial balance is complete and shows that everything is still in balance, the accounting team can move on to the next step in the process — Preparing the company’s financial statements.

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