A trial balance is a listing of each account used to post transactions and the current account balance.
The trial balance is a useful tool for reviewing your accounting entries and to make corrections before generating the financial statements. As a business owner, you should understand how the trial balance can be used, and where this document fits into the accounting cycle.
The accounting cycle is the process of recording each transaction that occurs in a business and ends when the financial statements are generated. The cycle is repeated each month and year, and your company should have a written procedure that documents how each step in the accounting cycle is performed.
Trial balance and the chart of accounts
Every business creates a chart of accounts, which is a list of each account needed to manage the business and a corresponding account number. As the company grows, the accounting department may add, subtract, or change the accounts used to post transactions.
A typical chart of accounts assigns account numbers to balance sheet accounts first, followed by income statement accounts. Cash accounts, for example, may be numbered from 1000 to 1005, while revenue accounts in the income statement are assigned 7000 to 7030.
Your trial balance is generated using the account numbers and descriptions in the chart of accounts.
Trial balance vs. general ledger
Accounting transactions are posted using journal entries, which post activity to accounts using double-entry accounting.
A company’s general ledger is a list of every transaction posted to the accounting records during a specific period of time. General ledger lists every account name and number in the chart of accounts, along with each debit and credit entry for a particular account.
There’s an important difference between the general ledger and the information in a trial balance. Consider your cash account for November, as an example. General ledger will list every transaction in the cash account for the month, while the trial balance will present the ending balance in cash.
The trial balance lists only the ending balances, and the general ledger lists every transaction, along with the ending balance. If you need to understand the details of a particular cash transaction, you review general ledger.
Posting journal entries
Double-entry accounting requires an accountant to use these rules to post journal entries:
- Debit entries: Debit entries are posted on the left side of each journal entry. Asset and expense accounts are increased with a debit entry, with some exceptions.
- Credit entries: Credit entries are posted on the right side of each journal entry. Liability and revenue accounts are increased with a credit entry, with some exceptions.
- Totals: The total dollar amount of debits must always equal credits. Accounting software requires each journal entry to post an equal dollar amount of debits and credits. The number of debit and credit entries, however, may be different.
- One of each: Every journal entry has at least one debit and one credit entry.
As an example, this journal entry is posted to record an asset purchase:
|Debit #5000 Equipment||Credit #1000 Cash $3,000|
|(To record purchase of equipment for cash)|
The journal entry includes the date, account numbers, account descriptions, dollar amounts, and the debit and credit entries. An explanation is listed below the journal entry so that the purpose of the transaction is easy to determine.
The general ledger detail for a particular account may include dozens or even hundreds of transactions in a given month. The cash account typically has the most activity of any account, since many transactions require a debit or credit entry to cash.
Here’s an example of the cash general ledger account:
|11/12||Sales collected in cash||$25,000|
Why create a trial balance?
An accountant uses the trial balance to perform a quick review of the financial condition of the business, and accountants may generate the trial balance multiple times each day.
Assume, for example, that your cash account balance is $30,000, and you then pay $5,000 in vendor invoices using cash. After posting the journal entries, you run trial balance to verify that the cash balance declined to $25,000 and that the accounts payable balance (amounts owed to vendors) has also declined by $5,000.
Much like the dashboard in your car, the trial balance is a tool to constantly check the financial status of a business. Here’s a portion of a trial balance:
|Trial Balance: 12/4/2018|
|#1200 Accounts receivable||$120,000|
The trial balance will include each balance for assets, liabilities, equity, revenue, and expense accounts.
The importance of adjusting entries
An adjusting entry is an accounting transaction that is required to comply with the accrual basis method of accounting. Generally Accepted Accounting Principles (GAAP) requires the accrual basis of accounting so that the financial statements are clearly stated.
If you’re owed $300 in interest on your company’s bank balance as of November 30th, for example, the accrual method requires your business to post interest income and to record an entry in interest receivable. The adjustment ensures that income is posted in the month that the interest is earned, regardless of when cash is received.
Here is the adjusting journal entry:
|Debit #1600 Interest receivable||$300|
|Credit #5100 Interest income||$300|
|(To record bank interest earned during November)|
Once the adjusting entries are posted, an updated trial balance is generated, and the adjusted trial balance is used to produce the financial statements.
A useful accounting tool
A trial balance is your best tool for constantly monitoring the impact of your accounting transactions. Get in the habit of reviewing your trial balance, so that you can quickly find errors or adjustments that need to be posted. Reviewing the trial balance frequently will help you generate accurate financial statements.