Ledger and Trial Balance Chapter Notes | Accountancy Class 11 - Commerce PDF Download

Meaning of Trial Balance

• A trial balance is a statement showing the debits and credits of all ledger accounts to verify accuracy.
• It simplifies preparing final statements by providing a summary of all account balances, instead of reviewing the entire ledger.

• A trial balance simplifies statement preparation by summarizing account balances, avoiding a full ledger review.
• Typically prepared at year-end, it can also be done monthly, quarterly, or semiannually.
• To prepare a trial balance:
  1. Ascertain each ledger account balance
  2. List each in the debit or credit column
  3. Total the debit and credit columns
  4. Verify they match.
• If they do not tally, it indicates that there are some errors.
• Generally, assets, expenses, and receivables have debit balances; liabilities, revenues, and payables have credit balances.

Showing the format of a trial balance

Remember that: 

• All assets, expenses, and receivables accounts should have debit balances.
• All liabilities, revenues, and payables accounts should have credit balances.

Objectives of Preparing the Trial Balance

• The trial balance is created to achieve the following goals:
• To check the mathematical correctness of the accounts in the ledger.
• To assist in finding mistakes in the records.
• To aid in preparing the financial statements, which include the Profit & Loss account and the Balance Sheet.

Purpose of Trial Balance

• The main goal of preparing a trial balance is to check if all the debits and credits are recorded correctly in the ledger.
• It acts as a summary of the ledger, listing all accounts and their balances.
• If the total of all debit balances equals the total of all credit balances, it indicates that the accounts are likely arithmetically correct.
• However, matching totals does not guarantee that all entries are accurate; it simply shows that debits and credits have been recorded properly.

Locating Errors

• If the trial balance does not match (i.e., the totals of the debit and credit columns are different), it means there is at least one error.
• Errors may happen at various stages in the accounting process, including:
  1. Calculating totals in subsidiary books.
  2. Posting journal entries into the ledger.
  3. Calculating account balances.
  4. Carrying account balances to the trial balance.
  5. Calculating totals for the trial balance columns.
• Even if debit and credit totals are equal, it does not ensure all entries are correct because some errors do not affect the equality of debit and credit totals.
• For example:
  1. A bookkeeper might debit the right amount to the wrong account, resulting in incorrect balances for two accounts, yet still allowing the trial balance to tally.
  2. Another mistake could involve recording an equal debit and credit for an incorrect amount, which also keeps the totals equal but makes the account balances wrong.
• Thus, just because the trial balance matches does not mean that all entries in the original books (like journals or cash books) are correct. However, equal totals suggest that certain types of errors likely did not occur.

Preparation of Financial Statements

• The trial balance serves as a link between accounting records and the creation of financial statements.
• When preparing a financial statement, there is no need to refer back to the ledger.
• Having a matching trial balance is the first step in preparing financial statements.
• All revenue and expense accounts from the trial balance are moved to the trading and profit and loss accounts, while all liability, capital, and asset accounts go to the balance sheet.

Preparation of Trial Balance

• Totals Method
• Balances Method
• Totals-cum-balances Method

Totals Method

• This method involves calculating the total amounts for the debit and credit sides of the ledger separately.
• These totals are then shown in the trial balance in their respective columns.
• The total amount in the debit column must equal the total in the credit column.
• This is because the accounts are based on the double-entry system.
• However, this approach is not often used in practice.
• This is because it does not effectively check the accuracy of the balances in different accounts.
• Additionally, it does not help in preparing financial statements.

Balances Method

• This is the most common method used in practice. In this approach, the trial balance is prepared by listing the balances of all ledger accounts. 
•  Then, the debit and credit columns are totalled to verify their correctness. 
•  The account balances are significant because they summarize the overall impact of all transactions related to each account, which is essential for preparing financial statements. 
•  Typically, instead of showing each individual debtor's account, a single total labelled sundry debtors is presented, and similarly, for creditors, a total labelled sundry creditors is shown.
  

Totals-cum-balances Method

•  This method combines elements of both the totals method and the balances method. 
•  It involves creating four columns: two for recording the total amounts of various accounts (debit and credit) and two for displaying the balances of these accounts (debit and credit). 
•  Despite its comprehensive nature, this method is rarely used in practice because it takes a lot of time and does not provide any significant advantages. 

Significance of Agreement of Trial Balance

• Error in totalling the debit and credit balances in the trial balance.
• Error in totalling subsidiary books.
• Error in posting totals from subsidiary books.
• Error showing account balances in the wrong column or wrong amount in the trial balance.
• Omission of an account balance in the trial balance.
• Error in calculating a ledger account balance.
• Error while posting a journal entry, such as posting the wrong amount, on the wrong side, or in the wrong account.
• Error in recording a transaction in the journal, like making a reverse entry or recording with the wrong amount.
• Error in recording a transaction in the subsidiary book with the wrong name or amount.

Classifications of Errors

• Errors of Commission
• Errors of Omission
• Errors of Principle
• Compensating Errors

1. Errors of Commission:

• These errors occur due to incorrect posting of transactions, wrong totalling, or incorrect balancing of accounts. For example, if Raj Hans Traders paid ₹25,000 to Preetpal Traders but posted only ₹2,500 to Preetpal’s account, this is an error of commission. Such errors are typically clerical in nature and often impact the trial balance.

2. Errors of Omission:

Errors of omission happen when a transaction is not recorded in the books. They can be of two types:

• Complete Omission: When a transaction is fully omitted, like failing to record credit sales of ₹10,000 to Mohan in the sales book.
• Partial Omission: When part of the transaction is omitted, such as recording sales in the sales book but not posting them to Mohan’s account.

3. Errors of Principle:

• These errors arise when accounting principles are not followed. For instance, if costs related to building improvements are incorrectly recorded as maintenance expenses, that’s an error of principle. Such errors can affect financial statements by misrepresenting income or assets but do not impact the trial balance.

4. Compensating Errors:

• Compensating errors occur when multiple errors cancel each other out, resulting in no net effect on the debits and credits. For example, if the purchases book is overstated by ₹10,000 and the sales returns book is understated by the same amount, the trial balance remains unaffected as the errors balance each other.

Searching of Errors

• If the trial balance does not match, it clearly shows that there is at least one error present.
• These errors must be found and fixed before creating the financial statements.

To identify and locate the errors, the accountant should follow these steps:

1. Recalculate the totals of the debit and credit columns in the trial balance.
2. Check the account names and amounts in the trial balance against those in the ledger to find any discrepancies or missing accounts.
3. Compare the current year's trial balance with the previous year's to spot any added or removed accounts and to see if there are any unexpected large differences.
4. Reassess the accuracy of the balances for each individual account in the ledger.
5. Double-check that postings from the original records into the accounts are correct.
6. If the difference between the debit and credit columns can be divided by 2, it might mean that an amount equal to half of the difference was incorrectly posted in another account. For example, if the debit total is greater by 1,500, it might be that a credit of 750 was mistakenly recorded as a debit. The accountant should review all debit entries of 750.
7. The difference may also suggest that a posting was completely missed. For instance, a difference of 1,500 could be because a credit of that amount was not posted. Thus, the accountant should check all credit entries of 1,500.
8. If the difference is a multiple of 9, it could indicate a transposition error. For example, if 459 is recorded as 954, the debit total would exceed the credit side by 495 (i.e., 954 - 459 = 495). This difference is divisible by 9. Errors due to a misplaced decimal point can also be checked using this method.

Rectification of Errors

• Errors that do not affect the trial balance
• Errors that affect the trial balance

This distinction is important because:

• Errors that do not affect the trial balance usually involve two accounts, making them easy to fix with a journal entry.
• Errors that do affect the trial balance typically involve one account, and fixing them may require a suspense account unless a journal entry is made.

Rectification of Errors that Do Not Affect the Trial Balance

These types of errors happen in two or more accounts and are often called two-sided errors. They can be corrected by making a journal entry that adjusts the correct debit and credit for the involved accounts. Examples of these errors include:

• Not recording an entry in the original books.
• Incorrectly recording transactions in the accounts.
• Failing to post to the correct account on the right side.
• Errors based on principles.

The process of rectification involves the following steps:

• Cancelling the impact of the wrong debit or credit by reversing it.
• Restoring the impact of the correct debit or credit.

To analyze the error, consider its effect on the accounts, which may include:

• Short debit or credit in an account.
• Excess debit or credit in an account.

Thus, a rectification entry can be made by:

• Debiting the account with the short debit or with the excess credit.
• Crediting the account with the excess debit or with the short credit.

Rectification of Errors Affecting Trial Balance

• Examples of such errors include: 
  1. Error in casting
  2. Error of carrying forward
  3. Error in balancing
  4. Error of posting to the correct account but with the wrong amount
  5. Error of posting to the correct account but on the wrong side
  6. Posting to the wrong side with the wrong amount
  7. Omitting to show an account in the trial balance
• If you find a mistake in the original entry books before they are recorded in the ledger, you can fix it by drawing a single line through the wrong amount.
• If the wrong amount is recorded in the correct ledger account, you can correct it in the same way or by making an additional entry for the difference.
• Make sure to add a note in the particulars column to explain the correction.
• It is important to avoid fixing mistakes by erasing or overwriting them, as this can damage the trustworthiness of the accounting records.
• Erasing can give the impression that you are hiding something.
• A better way to correct errors is to note the correction on the right side to balance out the error's impact.
• For example, if Shyam’s account was under-credited by ₹ 190, this can be corrected by making an additional entry of ₹ 190 on the credit side of his account.

Suspense Account

• When the trial balance doesn't match because of one-sided errors, the accountant must continue working on the financial statements.
• To balance the trial, the accountant records the difference on the shorter side as a suspense account.

Rectification of Errors in the Next Accounting Year:

• If mistakes occur during an accounting year and are not found and corrected before the financial statements are completed, the suspense account will stay open.
• The amount in the suspense account will be carried over to the next accounting period.
• When mistakes from one accounting year are discovered and corrected in the following year, the profit and loss adjustment account is updated.
• This update is done instead of directly changing the accounts for expenses or incomes to avoid impacting the income statement of the next period.
• This topic will be discussed in more detail as you continue your studies in accounting.