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

Introduction

Meaning of Trial Balance: A trial balance is a statement that lists the totals of debits and credits from all accounts in the ledger. Its main purpose is to check the mathematical accuracy of the postings made to the ledger accounts.

Importance in Accounting:

• A trial balance reflects the overall status of all accounts, aiding in the preparation of final statements.
• It simplifies the creation of final statements by providing a concise overview of all account balances, thus eliminating the need to examine the entire ledger.

Preparation Frequency:

• A trial balance is typically created at the end of an accounting year. However, organizations may prepare it at the end of any chosen period, such as monthly, quarterly, semi-annually, or annually, based on their needs.

Steps to Prepare a Trial Balance:

• Determine the balances of each account in the ledger.
• List each account and enter its balance in the appropriate debit or credit column.
• Sum the debit and credit columns.
• Check that the totals of the debit and credit columns match.

Limitations of a Trial Balance:

• Having a balanced trial balance does not definitively prove that the accounts are accurate.

Account Balance Expectations:

• Generally, assets, expenses, and receivables should show debit balances.
• Liabilities, revenues, and payables should show credit balances.

Format of a Trial Balance:

• All assets, expenses, and receivable 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 several key goals:
• To ascertain the arithmetical accuracy of the ledger accounts.
• To assist in locating errors in the accounting records.
• To aid in the preparation of financial statements, such as the Profit & Loss account and the Balance Sheet.
• It is important to note that:
  1. All assets, expenses, and receivable accounts will have debit balances.
  2. All liabilities, revenues, and payables accounts will have credit balances.

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 do 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 in the accounting records.
• Errors may occur 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 that 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 is essential for linking accounting records to financial statements.
• It summarizes account balances and is usually sufficient for creating financial statements without needing to refer back to the ledger.
• A matching trial balance indicates that debits and credits are recorded correctly. This is the first step in preparing financial statements.
• Revenue and expense accounts from the trial balance are transferred to the trading and profit and loss account.
• Liabilities, capital, and asset accounts are moved to the balance sheet.

Preparation of Trial Balance

Trial Balance Preparation Methods include:

• Totals Method: This method calculates and compares the total amounts for the debit and credit sides of the ledger.
• The totals are displayed in separate columns. The debit total must equal the credit total due to the double-entry accounting system.
• This method is less commonly used as it does not effectively verify individual account balances.
• Balances Method: This is the most commonly used method.
• It lists the balances of all ledger accounts, and the debit and credit columns are totaled to check accuracy.
• Account balances summarize the net effect of transactions, which is crucial for preparing financial statements.
• Only summary figures for sundry debtors and sundry creditors are shown instead of individual account balances.
• Totals-cum-balances Method: This combines aspects of both previous methods.
• It creates four columns: two for total amounts (debit and credit) and two for account balances (debit and credit).
• Despite its thoroughness, it is rarely used due to its complexity and time consumption.

Significance of Agreement of Trial Balance

• A balanced trial balance is important as it indicates that the debit and credit entries have been recorded correctly.
• However, a balanced trial balance does not guarantee the total accuracy of accounting records. It merely suggests that the postings are mathematically correct.
• Common errors that can still exist include:
  1. Error in totaling the debit and credit balances in the trial balance.
  2. Error in totaling subsidiary books.
  3. Error in posting totals from subsidiary books.
  4. Incorrectly showing account balances in the trial balance.
  5. Omission of an account balance.
  6. Errors in calculating a ledger account balance.
  7. Incorrect posting of journal entries.
  8. Errors in recording transactions in subsidiary books.
• While the trial balance helps check the correctness of debit and credit amounts, it is not definitive proof of the accuracy of accounting records.
• The trial balance acts as an arithmetical check within the double-entry system, ensuring accurate recording of transactions.

Classifications of Errors

Errors of Commission:

• These errors occur when transactions are incorrectly recorded, totals are wrong, or accounts are balanced incorrectly.
• Example: If Raj Hans Traders pays ₹25,000 to Preetpal Traders but only posts ₹2,500 to Preetpal’s account, this is an error of commission. Such errors are usually clerical and can affect the trial balance.

Errors of Omission:

• Errors of omission happen when a transaction is either not recorded in the books or not posted to the ledger.
• Complete Omission: This occurs when a transaction is fully omitted. For example, failing to record credit sales of ₹10,000 to Mohan in the sales book.
• Partial Omission: This occurs 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 from not adhering to proper accounting principles.
• They may occur due to misclassifying expenses or income between capital and revenue. Such mistakes can distort financial statements by inaccurately presenting income or assets.
• Although these errors affect financial reporting, they do not impact the trial balance.

Compensating Errors:

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

Searching for Errors

• If the trial balance does not match, it indicates that at least one error has occurred.
• Errors must be identified and corrected before preparing financial statements.
• Equal totals of debit and credit balances do not guarantee accounting accuracy, as some errors may not affect this equality.
• However, equal totals can suggest that certain types of errors are likely absent.
• To identify and locate errors, follow these steps:
  1. Recalculate the totals of the debit and credit columns in the trial balance.
  2. Verify account names and amounts in the trial balance against the ledger for discrepancies or missing accounts.
  3. Compare the current year's trial balance with the previous year's to identify any added or removed accounts and unexpected large differences.
  4. Reassess the accuracy of balances in each individual account in the ledger.
  5. Double-check the accuracy of postings from original records into the accounts.
  6. If the difference between debit and credit columns is divisible by 2, it may indicate that an amount equal to half the difference was incorrectly posted in another account.
  7. If the difference is a multiple of 9, it may suggest a transposition error, such as incorrectly recording 459 as 954.

• Rectification of Errors

• Errors are categorized based on their impact on the trial balance into:
  • Errors that do not affect the trial balance
  • Errors that affect the trial balance
• This distinction is crucial because:
  • Errors that do not affect the trial balance usually involve two accounts and can be easily fixed with a journal entry.
  • Errors that do affect the trial balance often involve one account, requiring a suspense account or a journal entry for correction.
• Rectification of Errors that Do Not Affect the Trial Balance
  • These errors occur in two or more accounts and are referred to as two-sided errors. They can be corrected through a journal entry, adjusting the correct debit and credit for the involved accounts.
  • Examples of such errors include:
    1. Not recording an entry in the original books.
    2. Incorrectly recording transactions in the accounts.
    3. Failing to post to the correct account on the right side.
    4. Errors based on accounting principles.
  • The process of rectification involves:
    1. Cancelling the impact of the wrong debit or credit by reversing it.
    2. Restoring the impact of the correct debit or credit.
  • To analyze the error, consider its effect on the accounts, which may include:
    1. Short debit or credit in an account.
    2. Excess debit or credit in an account.
  • A rectification entry can be made by:
    1. Debiting the account with the short debit or with the excess credit.
    2. Crediting the account with the excess debit or with the short credit.
  • Examples:
    • A credit sale of ₹10,000 to Mohan was not entered in the sales book (complete omission). To rectify, record the usual entry for the credit sale.
    • Credit sales to Mohan for ₹10,000 were recorded as ₹1,000 (error of commission). Mohan's account needs an extra debit of ₹9,000, and the sales account requires a credit of ₹9,000 to correct this.
    • Credit sales to Mohan for ₹10,000 were mistakenly entered as ₹12,000 (commission error). This causes a surplus debit of ₹2,000 in Mohan's account and an extra credit of ₹2,000 in the sales account, needing rectification.
    • A sale of ₹10,000 to Mohan was recorded in Ram's account instead (error of commission). Mohan's account does not reflect the sale, leading to confusion and inaccuracies.
    • The rent amount of ₹2,000 was incorrectly recorded as a payment made to the landlord. The landlord's account was charged instead of the rent account, necessitating a correction entry.
• Rectification of Errors Affecting Trial Balance: Errors that impact a single account can be corrected by providing a note in the affected account or by making a journal entry that uses a Suspense Account.
• Types of Errors: Common errors that may affect the trial balance include:
  • Error in casting
  • Error of carrying forward
  • Error in 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
• Correction of Errors:
  • If a mistake is found in the original entry books before they are recorded in the ledger, it can be corrected by drawing a single line through the incorrect amount.
  • If the wrong amount is recorded in the correct ledger account, it can be corrected in the same way, or an additional entry for the difference can be made.
  • It is essential to add a note in the particulars column to explain any corrections made.
• Best Practices for Corrections:
  • Avoid erasing or overwriting mistakes, as this can damage the trustworthiness of the accounting records.
  • Erasing can create the impression of hiding information.
  • A more reliable method is to note the correction on the right side to balance the effect of the error.
• Example of Correction:
  • 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.
• Another Example:
  • If the purchases book indicated a shortage of ₹1,000, this affects the purchases account, specifically the debit side.
  • The total amount recorded in the purchases book should be updated accordingly to reflect this adjustment.
  • It is crucial to accurately represent this adjustment in the financial records to maintain accuracy.
• Suspense Account
  • A suspense account is used when the trial balance does not match due to one-sided errors.
  • The accountant records the difference on the shorter side of the trial balance in the suspense account.
  • This is a temporary measure to allow the accountant to continue working on the financial statements until the errors are identified and corrected.
• Example of Suspense Account
  • Consider an organization where sales made to Diwakar and Sons were not recorded.
  • The trial balance shows a credit total of ₹50,000 and a debit total of ₹35,000, resulting in a difference of ₹15,000.
  • This difference is placed in a suspense account to balance the trial.
  • Until all errors affecting the trial balance are found, the suspense account remains open.
  • Once errors are identified, the amounts can be transferred from the suspense account to the correct accounts.
• Steps for Correcting One-Sided Errors
  • Identify the affected account.
  • Determine the amount of excess debit/credit or short debit/credit.
  • If there is an excess debit or short credit, credit the affected account.
  • If there is an excess credit or short debit, debit the affected account.
  • Complete the journal entry by adjusting the suspense account accordingly.
• Examples of Rectifying Errors Using a Suspense Account
  • The credit sales of ₹10,000 to Mohan were not recorded. This is a partial omission error.
  • The correct entry should have reflected the full ₹10,000.
  • The rectification entry will involve crediting the suspense account to correct this oversight.
  • Another example is when credit sales of ₹10,000 to Mohan were mistakenly recorded as ₹7,000, an error of commission. This under-debits Mohan's account by ₹3,000.
  • Correcting this requires adjusting the suspense account for the amount of the under-debit.
  • Errors in casting subsidiary books impact totals, not individual accounts. For example, if the purchases book is overcast by ₹1,000, only the purchases account is affected.
  • The rectification entry would adjust the purchases account by debiting or crediting the suspense account.
• Rectification of Errors in the Next Accounting Year
  • If errors are not found before finalizing financial statements, the suspense account's balance carries forward to the next period.
  • When the errors are corrected in the following year, adjustments are made to the profit and loss adjustment account to avoid affecting the current year's income statement.

• Guiding Principles of Rectification of Errors

  • Errors in Books of Original Entry: All postings are assumed correct if the error is in the original entry.
  • Errors at the Posting Stage: Recording in subsidiary books is assumed correct.
  • Posting to a Wrong Account: If posted to the wrong account, it is assumed the posting was on the correct side and with the correct amount.
  • Correct Account but Wrong Amount: It is assumed that the posting was done correctly on the right side.
  • Wrong Account on Wrong Side: Assumes posting was done correctly with the original transaction amount.
  • Wrong Account with Wrong Amount: Assumed posting was done on the right side.
  • Correct Account on Wrong Side: Assumed posting was done with the correct amount.
  • Individual Transactions in Subsidiary Books: Errors relate only to individual accounts, impacting specific transactions without affecting the overall accounts.