Introduction

This part of our study is a furtherance of the level one tutorial series we have already interrogated. This part will entail an intermediate in depth review of the trial balance as one of the steps/ stages in the accounting cycle. First, we have defined the term trial balance and its basic aspects and therefore in this part three, we are going to incorporate further details of paramount importance.

Definition: Trial Balance

As defined in level one of this accountancy tutorial series, a trial balance in other words refers to a list of end of period (closing) ledger account balances. It is the prerequisite tool for the preparation of all other financial statements of an organization. The trial balance is prepared at the end of a period of time which can either be less than, or a year or more than a year for it depends on the purpose of preparing one. The content is the closing DR and CR balances and totals of assets, expenses, capital, liabilities and incomes of a business as it was demonstrated in  level one tutorial series.

trial-balance-level-2

NB1: Opening stock is part of the trial balance components and it is recorded on the debit side.

NB2: Closing stock is indicated as additional information. Hence it is not part of the items in the trial balance

Purposes of a Trial Balance

The following are some of the usefulness of trial balance;

  1. It is the prerequisite for the preparation of other financial statements. Hence it is equal to a working paper.
  2. It ensures that the double entry principle is adhered to such that for every DR entry, a corresponding CR entry is made by the person concerned. It the two sides of the trial balance does not equal, then the trial balance will detect that and corrective measures undertaken
  3. It is a summary of all the ledger accounts affected by transactions in that particular period under investigation.
  4. It is used in identification and rectification of errors

Accounting Errors

When transactions are recorded either in the source documents, books of original entry or in the various ledger accounts, error of diverse nature may occur. As a result of that, the financial reports presented at the end of the financial period may not portray a true and fair status of the business for the information will be misleading. This errors are broadly classified into two categories;

  1. Errors detected by the Trial Balance
  2. Errors not detected by the trial balance
  1. Errors Detected by the Trial Balance

    The essence of preparing the trial balance is to check if there are errors that occurred during the recording of the business transactions. If this is the case, the DR and CR sides of the trial balance fails to balance. Such errors are detected by the trial balance and then corrected. Examples of such errors are;

    1. Single entry error-if you only debit one account and fail to credit the corresponding ledger account or you credit one account and ignore debiting the other account affected by that particular transaction.
    2. Arithmetic error-if one fails to accurately add, or subtract or multiply/divide a figure of concern.
    3. Transposition of values/numbers-when recording of values in the bookkeeping documents or accounts, the accountant may record the wrong value either record a bigger or smaller value than it is.

    Errors detected by the trial balance through failure to balance is corrected by introducing a SUSPENSE account. The suspense account value assumes either a DR or CR value based on the side of the trial balance with the shortage. That is, if the DR side of the trial balance has a shortage, the suspense account will have a DR balance and the vice versa is true.

    Illustration 1

    Assume that the trial balance of Our Co. ltd had the following details (extract of previous illustration-2)

    trial-balance-level-2

    Suppose the DR side had a total of $2,447,000 as compared to CR which had $2,555,000, then to rectify the difference, we introduce the suspense account as shown in the trial balance and then track back the cause of the error or errors so as to adjust. A suspense account is concurrently opened with the corresponding DR or CR balance brought down. When corrections are done effectively, the suspense account clears/close down. In the above case, the suspense account appears as follows;

    trial-balance-level-2

    To correct this error, one has to go back and track the cause of the mistake by checking in source or books of original entry and or the various ledger accounts. The error may have occurred in either of those documents. Once traced, a general journal is used to correct the entry (remember the functions of general journal).

    For instance, in this case, the mistake was may be a transaction which took place on 15th  whereby the organization bought machinery costing $108,000 on credit from Industrial ltd but was only credited in “other creditors” account but not in the respective fixed asset account (an error of single entry). To correct this anomaly, you;

    DR Motor Vehicle account $108,000

    CR Suspense Account                     $108,000

    If we use a general journal, the entries will be as follows;

    trial-balance-level-2

    After correction, the outcome appears as;

    trial-balance-level-2

  2. Errors Not Detected by the Trial Balance

    The assumption that a trial balance with equal amounts of DR and CR side represent accounting entries which are error free may not always be correct. This is because although the two sides may balance, sometimes some errors may not be detected by the trial balance. Such errors are said not to affect the trial balance. A general journal is used to correct the errors. Those errors are classified in to the following categories;

    1. Error of Omission
    2. Error of Commission
    3. Error of Principle
    4. Error of Original Entry
    5. Error of Complete Reversal
    1. Error of Omission

      As the name suggests, the error involves total exclusion of a transaction. Such that the transaction that took place at a particular time was not recorded in any of the documents of the business, be it source document, book of original entry or ledger account. The point is that although the error has occurred, the trial balance still balances. An example of error of omission is a case where a buyer bought goods on credit but was totally ignored.

      Illustration 2

      3/5/2018 Joyce purchased goods worth $230,000 and were not recorded anywhere in the books of accounts of Our Co. ltd. This error will be corrected by use of a general journal whereby we will DR trade debtor-Joyce a/c and CR sales a/c as shown herein

      trial-balance-level-2

      NB: That since the transaction had not been recorded at all, the correction will involve equal debiting and crediting the relevant ledger accounts as guided by the journal.

    2. Error of Commission

      This is an error whereby a transaction is recorded in a wrong ledger account but of the same class of the account which was to be posted with the entry. For example if a transaction is wrongly recorded in Wilson account instead of Watson account whereby both accounts are either trade debtors or trade creditors which is categorized as personal accounts.

      Illustration 3

      12/5/2018 Watson bought goods amounting to $102,000 on credit from Our Co. ltd. The seller recorded the entries as follows;

      DR Trade Debtor-Wilson a/c $102,000

      CR sales a/c                             $102,000

      Correction is done as follows

      trial balance example

      NB: Watson a/c was debited to increase the total value of goods he has bought on credit whereas the Wilson a/c was credited to eradicate the excess charge in his account.

    3. Error of Principle

      This is an error whereby a transaction is recorded in a wrong ledger account in a different class of the account which was to be posted with the entry. For example if a transaction is wrongly recorded in motor vehicle expense account instead of motor vehicle account. The accounts in this case are in different classes for motor vehicle expense account is a nominal account while motor vehicle account is a real account.

      Illustration 4

      16/5/18 Our Co. ltd paid motor vehicle expenses amounting to $456,000 in cash but it was DR in motor vehicle account. The correction would be as

      general ledger example

      NB: That motor vehicle a/c was credited to reduce its total value and the respective expense account was debited to increase its value to avoid cases of understating the net profit.

    4. Error of Original Entry

      It is an error where by an entry is recorded wrongly in the first instance. Especially wrong recording in the source document or book of original entry. Once this happens, the mistake is inherently transferred to all other accounting records. To correct this error, logic has to prevail to internalize the adjustment to undertake to correct the mistake rightly. So there is no particular way of correcting the mistake. The entrepreneur/ learner need to logically reverse the effect of the error by doing the right corrections. An example of such an error is when a transaction is overcast or under cast.

      Illustration 5

      Our Co. ltd sold goods on credit to Whales co. ltd for $434,000. It was recorded in the outgoing invoice as $443,000. This was an error of overcast. The scenario is that the Trade Debtor-Whales A/C was DR with 443,000 and also the sales a/c was CR with the same amount (ie $443,000). To correct this mistake, the accountant need to consider the excess amount (ie $9,000) which should be reversed in the same accounts as follows;

      trial balance preparation

    5. Error of Complete Reversal

      It is an error that involves entry of business transactions in the relevant accounts but in an inverted manner. Such that, an account that ought to be debited is credited instead and an account which ought to be credited is debited and the vice versa is true.

      Illustration 6

      Our Co. ltd paid a trade creditor $345,000 on cash basis. However, the entries were as follows;

      DR Cash account                                $345,000

      CR Trade Creditor                              $345,000

      To correct this error, another reversal, entry is needed to revert the erroneous entry as shown herein by considering making a reverse entry with double amount as shown herein

      general ledger example image

      NB: By reversing the entry of the same accounts using a double amount ensures that the wrong entry is cancelled and at the same time the new correct entry is initiated in the right accounts.

    6. Error of Compensation

      Error of compensation refers to a mistake that occurs when a wrong entry in one account is coincidentally compensated by another wrong entry in another account. The entries are such that the monetary value of the original error is reversed by another mistake of equal amount. In this case, the ledger accounts have inherent mistakes which is unnoticeable although the two sides of the balance sheet are balancing.

      Illustration 7

      The following transactions took place in Our Co. ltd

      22/5/18 Sold stock on credit to a trade debtor $160,000 which was recorded in the relevant books of accounts as $106,000. That is

      DR Trade Debtor a/c              $106,000

      CR Sales a/c                            $106,000

      28/5/18 bought machinery of $100,000 on credit from Overseas Ltd which was recorded in the relevant ledger accounts as follows;

      DR Machinery account                                               $154,000

      CR Other Creditor-Overseas Ltd account                  $154,000

      Scenario One: With wrong entries made, the trial balance totals would appear as;

      trial-balance-level-2 example

      NB: By undertaking the above course of action, the mistake is corrected.

      Scenario Two: If correct entries were made, the trial balance totals would appear as;

      trial balance example

      NB: In both scenarios, the two trial balance statement have balanced, yet there are error, which occurred unnoticeably. To rectify such mistakes, the following entries should be undertaken as shown herein

    7.  

Unadjusted Trading, Profit and Loss Account Statement

Unadjusted trading, p& l account is a financial statement which does not reflect true and fair financial position of the firm due to inherent errors which have occurred. There exists financial implication once an error occurs hence the profitability of the organization is either understated or over casted. This calls for further adjustment to rectify the mistakes. To achieve this objective, one has to consider logical implication of the items affected so as to correctly adjust the profit value. The framework for correcting errors are;

Step one: Establish erroneous accounting entries

Step two: Determine the correct entry.

Step Three: Internalize step one and two and decide the logical effect on other aspects accounting. Then consider the adjusted p& l amounts to prepare the correct financial statement

unadjusted urading profit and loss account statement 

NB: Further adjustment on all assets, capital and liabilities affected is necessary.

SUMMARY

In part three, the focus was on trial balance which is a summary of balances brought down and totals of all accounts that were affected by certain business transactions that took place at specific period of time. The statement has several functions that are helpful to the management and the owners by extension. The trial balance also incorporates the opening inventory as a debit entry component for it is assumed that this element forms part of purchases cost of the year. Contrariwise, the closing inventory is excluded from the trial balance monetary amount totals for this item is brought forward to form part of purchases cost of the following accounting period.

Apart from the trial balance representing a summary of all ledger account balances, it is used as a tool for correction of errors and hence it is further used to provide data to correct the end of the year profits or losses. The errors which were considered in this part were of two kinds; errors detected and errors not detected by the trial balance. Those errors detected by the trial balance is evident when the trial balance fails to equal and a suspense account is used to rectify that. Whereas, the errors not detected by the trial balance have no apparent proof per se’ but once identified, corrections can be done based on the type of error that occurred. Lastly and not the least, in normal circumstances, a trial balance is used as the source of information for the end of financial period preparation of trading and profit and loss account which usher balance sheet.