Trial Balance and Rectification of Errors Chapter Notes | Accountancy Class 11 - Commerce PDF Download

Meaning of Trial Balance

A trial balance is a report that list The mistakes that affect only one account can be fixed by adding a note in the affected account or by making a journal entry using a Suspense Account. The Suspense Account will be explained later in this chapter.

Examples of such mistakes include: 

• Error of casting
• Error of carrying forward
• Error of balancing
• Error of posting to the right account but with the wrong amount
• Error of posting to the correct account but on the wrong side
• Posting to the wrong side with the wrong amount
• Failing to show an account in the trial balance
• If a mistake is found in the original entry books before it is sent to the ledger, it can be corrected by crossing out the wrong amount with a single line and writing the correct amount above it, then initialing it.
• A mistake in the amount posted to the right ledger account can also be corrected in the same way, or by making an extra posting for the difference and adding a note in the particulars column.
• However, mistakes should never be fixed by erasing or overwriting, as this can harm the credibility of the accounting records and suggest that something is being hidden.
• A better approach is to note the correction on the correct side to cancel out the mistake.
• For example, if Shyam’s account was credited short by ₹ 190, this can be corrected by adding an extra entry of ₹ 190 on the credit side of his account.
•  process because it illustrates the overall status of all accounts.
• The trial balance helps in creating final statements by providing the balances directly, which simplifies the accountant's job.
• Instead of checking each account in the entire ledger, the accountant can simply refer to the trial balance for the necessary balances.
•  Typically, a trial balance is prepared using the current balances of accounts, presenting them in a structured way.

Showing format of a trial balance

• A trial balance is usually created at the end of an accounting year.
• However, an organization can also prepare a trial balance at the end of any chosen time period, such as: 
  • Monthly
  • Quarterly
  • Half yearly
  • Annually
• The steps to prepare a trial balance include: 
  • Determine the balances of each account in the ledger.
  • List each account and enter its balance in the appropriate column: 
    • Debit or Credit column as needed.
    • If an account has a zero balance, include it in the trial balance with zero in the appropriate column.
  • Calculate the total for the debit balances column.
  • Calculate the total for the credit balances column.
  • Check that the total of the debit balances equals the total of the credit balances. If they do not match, it indicates there are some errors that need to be checked.
• 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 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:
  • Calculating totals in subsidiary books.
  • Posting journal entries into the ledger.
  • Calculating account balances.
  • Carrying account balances to the trial balance.
  • 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 this equality.
• For example:
  • 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.
  • 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 account, while all liability, capital, and asset accounts go to the balance sheet.

Preparation of Trial Balance

Trial Balance Preparation Methods:

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

Totals Method:

• This approach involves calculating the total amounts for both the debit and credit sides of the ledger separately. These totals are then displayed in the trial balance in their respective columns. The total amount in the debit column must match the total in the credit column because the accounts follow the double entry system. 
• However, this method is not commonly used in practice since it does not effectively confirm the accuracy of the balances in different accounts or assist in creating 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 totaled 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 labeled sundry debtors is presented, and similarly, for creditors, a total labeled 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

For an accountant, it is crucial that the trial balance matches. A balanced trial balance indicates that the debit and credit entries for each transaction have been recorded correctly. However, it's important to note that a balanced trial balance does not guarantee the complete accuracy of accounting records. It only suggests that the postings to the ledger are mathematically correct. Still, mistakes may exist that do not affect the balance, or errors might cause the debits and credits to be unequal. Common errors include:

• Error in totaling the debit and credit balances in the trial balance.
• Error in totaling 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.

Types of Errors

Considering the nature of errors, they can be categorized into four main types:

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

Errors of Commission:

• These errors occur due to incorrect posting of transactions, wrong totaling, 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.

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.

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.

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 accountantshould follow these steps:
  • Recalculate the totals of the debit and credit columns in the trial balance.
  • Check the account names and amounts in the trial balance against those in the ledger to find any discrepancies or missing accounts.
  • 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.
  • Reassess the accuracy of the balances for each individual account in the ledger.
  • Double-check that postings from the original records into the accounts are correct.
  • 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.
  • 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.
  • 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 can be divided into two main types based on their impact on the trial balance:

• 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:

• Canceling 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

The errors affecting a single account can be fixed by providing a clear note in the account that is impacted or by making a journal entry using a Suspense Account. Details about the Suspense Account will be discussed later in this chapter.

• Examples of such errors include: 
  • Error of casting
  • Error of carrying forward
  • Error of balancing
  • Error of posting to the correct account but with the wrong amount
  • Error of posting to the correct account but on the wrong side
  • Posting to the wrong side with the wrong amount
  • Omitting to show an account in the trial balance
• If an error occurs in the original entry books and is found before it is entered into the ledger, it can be corrected by drawing a single line through the incorrect amount, writing the correct amount above it, and signing it. 
• Similarly, if the wrong amount is posted to the correct ledger account, it can be corrected by the same method or by making an additional entry for the difference and adding a note in the particulars column. 
• It is important to avoid correcting errors by erasing or overwriting, as this can undermine the integrity of accounting records and suggest that something is being hidden. 
• A better approach is to note the correction on the appropriate side to offset the effect of the error. 
• 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 some mistakes made during an accounting year are not found and corrected before the financial statements are finalized, the suspense account will remain open. 
•  The balance in the suspense account will be carried over to the next accounting period. 
•  When errors from one accounting year are identified and fixed in the following year, the profit and loss adjustment account is adjusted. 
•  This adjustment is done instead of directly changing the accounts for expenses or incomes to prevent affecting the income statement of the next period. 
•  This topic will be explored more in-depth as you progress in your accounting studies.