The terms trial balance and trial balance period refer to an error-checking step in the accounting cycle. The terms have meaning only in companies that use a double entry accounting system.
Exhibit 1 below shows the major steps in the accounting cycle. Firms complete the entire cycle once every accounting period. Here, note that accountants create a trial balance after posting all the period's transactions to the general ledger but before they transfer account balances to the period's financial reports.
Trial Balance in the Accounting Cycle
Exhibit 1 summarizes the sequence of steps in the Accounting Cycle.
Exhibit !. The accounting cycle. Transactions (Step 1) enter the journal (step 2) when they occur. Accountants transfer (post) journal entries to a ledger as the 3rd step. As a 4th step, they check entries with a trial balance and correct them if necessary. The final step occurs when the firm publishes financial statements. Note, however, however, that public companies must also complete the cycle by having reports audited and then filing them with securities authorities.
The trial balance uses data from all of the firm's open general ledger accounts. The "trial" itself simply compares two sums: total debits and total credits.
- When the firm applies double entry principles correctly, total debits from all accounts must equal total credits.
- A mismatch between trial debit and credit sums means that one or more accounts includes errors or omissions.
When the trial balance fails, accountants search for several kinds of errors that might cause the mismatch:
- Firstly, a debit entry in one account did not bring an equal and offsetting credit entry in another account.
- Secondly, some transactions either did not enter the system, or were entered into inappropriate accounts.
- Thirdly, account balance calculations include other errors in data entry or mathematics.
The trial balance test, incidentally, is not comprehensive error checking. Quite a few other kinds of errors can enter the system, while leaving total-debits equal to total credits. As a result, the trial balance period calls for several other kinds of error checking besides the trial balance itself.
Explaining Trial Balance and Trial Balance Period in Context
Sections below further define, explain, and illustrate trial balance. Note especially that the term appears in context with related terms and concepts from the fields of bookkeeping, accounting, and business analysis.
- What is a trial balance?
- The trial balance period: Built in error checking.
- Where is the trial balance period in the accounting cycle?.
- Calculating a trial balance.
- Trial balance results become the new Income statement and Balance sheet.
- Finding, adjusting, and fixing trial balance errors.
The trial balance highlights a well known advantage of the double entry system—built in error checking.
- Note that errors are more likely where accounting is still "by hand" or manual, with pencil and paper. Errors are less likely with computer-based systems. This is because modern accounting software runs several kinds of error checking, continuously, with every transaction.
- The trial balance can still overlook other kinds of accounting errors. It will not detect, for instance, transactions that should have been posted but were not. For more on these kinds of errors, see Finding Errors, below.
When the trial balance does not balance, accountants try to find and correct the error immediately. If the reason for the error is obscure or not easy to find, however, they may create temporary adjustments in certain accounts. These restore the debit-credit balance temporarily while they search for the problem.
The trial balance period is the time between final posting to the ledger and transfer of account balances to financial statements. Accountants use this time to find and correct errors the trial balance reveals. And, they also to search for errors that the trial balance overlooks. The firm would much rather find errors itself during the trial balance period, than having external auditors find them after publishing.
Total Debits Must Equal Total Credits
The debit and credit totals in the trial balance must match, in order to build the new Income statement and Balance sheet correctly. And, the firm must find and fix all accounting errors that lead to the mismatch before publishing the period's statements. Also, they must find and fix other material errors underlying the account balances during the trial balance period, as well.
Trial Balance Period Also Includes Reconciliation
Note that the trial balance period also includes reconciliation, the process of checking account balances against other sources. Bank statements should agree with ledger balances for cash accounts, for instance. And, liability accounts for bank loans should agree with the lender's account statements, and so on.
Good Reason for Rigorous Error Checking
Board members and corporate officers have good reason to be very sure that error checking is rigorous and thorough. The firm's financial statements will appear, for instance, in the Annual Report to shareholders. The statements will also to go to tax authorities, regulators, bond-rating firms, and potential lenders. In all cases, they must include a written "opinion" by external auditors. And, in most cases, the only acceptable opinion is the highest possible rating, an Unqualified opinion. All involved want to avoid a lesser opinion, "Qualified," or even worse, "Adverse."
The trial balance calculation has in view every active account from the company's chart of accounts and general ledger. Trial balance results will look like Exhibit 4, below, essentially a table of accounts and account balances.
- Note that each account carries one kind of balance only, either a credit balance or a debit balance.
- The table registers debit and credit balances in separate columns, and with column totals in the table's bottom row.
- The trial balance test, of course, occurs in the table's bottom row, where the two kinds of totals either match or do not match.
Note especially that this calculation does not require adding up every debit and every credit transaction from every account. The same results appear from simply adding instead the account balances from the general ledger, as in Exhibit 4.
Example Account Balance : Cash on Hand
Exhibit 2, below, helps explain the meaning of account balance in this context. Consider, for instance, just one account, "Cash on hand." Debit (DR) and credit (CR) transactions in this account for have been posted from the journal to the general ledger. The ledger organizes transactions by account, in so-called "T-accounts," such as the example in Exhibit 2.
Note that total debits and total credits to a single account are not necessarily equal, either for the period or for the account's entire history. Note especially that the difference between debit and credit totals across the account's history, represents the current account balance.
Debit and Credit Impacts in Different Kinds of Accounts
Exhibit 3, below, shows that two of the five major account types show debit balances, whereas the other three account types show credit balances. Note that the five account types belong to two higher level categories. These categories are as follows:
- Firstly, Balance sheet accounts.
These include (1) Asset accounts, (2) Liability accounts, and (3) Equity accounts.
These 3 account types make possible the Balance sheet equation:
Assets = Liabilities + Equities
- Secondly, Income statement accounts.
These include (4) Revenue accounts and (5) Expense accounts.
These 2 account types make possible the Income statement equation:
Income = Revenues – Expenses
Exhibit 3 also shows impact of debit and credit transactions in each of account type.
|Exhibit 3. The five major kinds of accounts. A positive balance in an Asset category account or Expense account is a debit balance. A positive balance in a Liability account, Equity account, or a Revenue account, is a Credit balance.|
End of Period Balances for All Accounts
Now consider the account balances at end of period. This is after all the period's transactions post to the ledger T-accounts. Looking only at account balances, the trial balance results appear below as Exhibit 4:
|Acct. No||Aerofirma Corporation Accounts |
Fiscal Year 20XX
|Debit Balance||Credit Balance|
|Asset Accounts - Current Assets|
|101||Cash on hand||12,700|
|139||Finished goods inventory||3,830|
|163||Factory manufacturing equipment||10,560|
|Liability Accounts - Current Liabilities|
|260||Bonds payable ||1,400|
|280||Bank loans payable||3,100|
|410||Product sales revenues||13,000|
|430||Rental property revenues||1,200|
|450||Interest earned revenues||300|
|Expense Accounts - Cost of Goods Sold|
|520||Raw materials costs||5,100|
|530||Direct labor costs||5,490|
|540||Indirect labor costs||3,730|
|550||Manufacturing plant costs||2,780|
|Exhibit 4. General ledger account balances for a company at the end of the reporting period. The trial balance test simply compares total debit balances to total credit balances. In this case, the totals match and the trial balance therefore does not reveal any accounting errors. (Note that for simplicity, this list of accounts is unrealistically short. Also for the sake of simplicity, the Exhibit does not include contra accounts, drawing accounts, depreciation expenses, or taxes.|
Passing the Test
In Exhibit 4, the trial sums in this example balance. That is because the total of debit balances equals the total of credit balances. The mathematics behind this result also mean that the sum of individual debit transactions equals the sum of individual credit transactions.
A successful trial balance notwithstanding, accountants will still check careful for the other kinds of accounting errors that do not impact a trial balance. Once all errors have been corrected, the account balances are ready for publication in the period financial accounting reports (see the final section in this article).
For the most part, line items on the period's Balance sheet and Income statement are nothing more than account names. This should obvious in Exhibit 4 above, for instance. And, figures reported for each item are simply the account balances.
In fact, when accountants are confident that the account balances are error-free, they build the new Balance sheet and Income statement directly from the list of accounts and their balances. Exhibits 5 and 6 below show the results.
Example: Creating the New Income Statement
Consider first the revenue category accounts and expense category accounts. These are also known as "Income statement accounts" and they do indeed make up the Income statement contents. In the case of this very simple example, using account balance figures Exhibit 4 above, the company's Income statement appears as Exhibit 5 below shows:
|Aerofirma Corporation Income Statement |
for Fiscal Year 20XX
|Product sales revenues||13,000|
|Services sales revenues||5,030|
|Rental property revenues||1,200|
|Interest earned revenues||300|
|Raw materials costs||5,100|
|Direct labor costs||5,490|
|Indirect labor costs||3,730|
|Manufacturing plant costs||2,880|
|Exhibit 5. The Income statement results as a table of Revenue and Expense accounts in the Exhibit 4 trial balance results.|
Example: Creating the New Balance Sheet
The remaining account categories (Asset, Liability, and Equity accounts) are called "Balance sheet accounts." These accounts and their balances do indeed make up the company's end-of-period Balance sheet, as Exhibit 6 below shows:
|Aerofirma Corporation Balance Sheet |
at the end of Fiscal Year 20XX
|Cash on hand||12,700|
|Finished goods inventory||3,830|
|Factory manufacturing equip.||10,560|
|Bank loans payable||3,100|
|Total owners equity plus inc||19,130|
|Total liabilities plus equity||29,980|
|Exhibit 6. The Balance sheet results as a table of Asset, Liability, and Equity accounts in the Exhibit 4 trial balance results.|
Net income, Retained Earnings, and Dividends on These Statements
Notice here that the "Net income" result from the Income statement was inserted into the current Balance sheet under "Owners Equity." When the Balance sheet is finalized, the net income value will indeed appear here, either as retained earnings, and/or as dividends.
When the trial balance balances, as in the previous section, the Balance sheet will also balance. And, the Income statement will show correct net income.
If the debit and credit balance totals do not match in the trial balance exercise, there is clearly an accounting error somewhere in the account balances. The firm will try to find errors responsible for the mismatch, and correct them, before publishing financial statements. During the trial balance period, accountants will also search for and try to fix other kinds of accounting errors that the trial balance does not reveal.
Material errors in the account balances that are not found and fixed before financial statements are published may result in an external auditor's opinion that is either "Qualified" or "Adverse."
The Trial Balance Reveals Some Kinds of Errors
A mismatch between debit and credit totals in the trial balance usually means that one or more transaction postings from journal to ledger are either in error or missing. Accountants may ultimately have to examine every debit-credit pair of journal entries to find the error.
There are, however, some well known indicators for certain kinds of problems. These help reveal specific errors without having to resort to a complete transaction-by-transaction review. For instance:
- If an account balance incorrectly appears as debit balance when it should be a credit balance (or the reverse), the difference between the debit total and credit total will be twice the value of this balance. And, the difference will divide evenly 2.
Therefore, when the accountant finds a trial balance difference divisible by 2, the first step is to look for an account balance exactly half the difference. That is most likely the misplaced balance.
- When the difference between debit and credit totals is evenly divisible by 9, this is a mathematical indicator that the account balances may include a transposition error in one of the balances.
A debit balance that should really be 12,578 may have been recorded as something like 12,587, for instance.
- When the difference between debit and credit totals is divisible neither by 9 or by 2, it is possible that a single debit or credit balance is missing from the account lists.
Making Account Balance Adjustments
Because the trial balance must balance, accountants may also adjust certain accounts, so that total debit and credit balances match. Adjustments are not so much a matter of fixing errors, as they are improvements in the accounting accuracy. The intent is to match revenues and expenses more correctly to the appropriate period.
Adjusting entries for the purpose balancing the trial balance are typically made in two kinds of expense and asset category accounts, accrual accounts and prepayment accounts:
- Adjustments to accrual accounts (such as accrued depreciation, or accrued interest expense) are made to reflect more accurately the timing of actual expense accrual.
- Adjustments to prepayment accounts (such prepaid insurance, office supplies, or floor space rental) are made so as to more accurately match actual timing for usage the goods or services.
The Trial Balance is Blind to Other Kinds of Errors
The trial balance test does not detect the following kinds of errors.
- The paired debit and credit figures for a transaction may both match but still be incorrect. Such a mistake may be accidental or it may be deliberate deception by the accountant. Either way, the trial balance is blind to the problem.
- Transactions that should enter the system are omitted. This is an error of omission, not visible to the trial balance.
- The firm makes an entry as a debit to an account when it should have a credit, and its corresponding co-transaction registers as a credit when it should be a debit. This is an error of reversal. When this happens, total debits still equal total credits.
- The firm may enter a transaction in the correct kind of account (e.g., "Asset account" or "Expense account") but still choose an incorrect account within the category. The contributions to total debits and total credits will still be equal.
- Two or more errors in different accounts may be offsetting, so as to cancel each other. If, for instance, a credit transaction in one account is $100 too high, and if in another account a debit transaction is $100 too high, the trial balance will still balance.
Remaining questions for auditors and regulators
If such errors enter the financial statements, the questions for auditors and regulators then have to do with materiality and intent.
- They will ask if the errors and their consequences are large enough and important enough to mislead decision makers and investors. In other words, Are the errors material?
- They will also attempt to determine if the errors represent accidental oversights or deliberate distortion of financial results (see Materiality Concept).
For this reason, company management and accountants will use the trial balance period to rigorously search out and correct all accounting errors--whether they impact the trial balance or not.