Trial Balance and Rectification of Errors

Meaning Of Trial Balance

After recording transactions in the Journal (or subsidiary books) and posting them to the Ledger accounts, the next step in the accounting cycle is to prepare a Trial Balance. A Trial Balance is a statement prepared at the end of an accounting period or on a specific date listing the balances (or sometimes totals) of all Ledger accounts.

The fundamental principle of the double-entry system is that for every debit, there is an equal credit. Therefore, the total of all debit balances in the Ledger should theoretically equal the total of all credit balances. The Trial Balance is prepared to test this arithmetic equality.

Definition:

A Trial Balance is a statement prepared with the debit and credit balances (or totals) of Ledger accounts to test the arithmetical accuracy of the books of accounts.

Key characteristics:

• It is a statement, not an account.
• It lists all Ledger accounts (Real, Personal, and Nominal).
• It can be prepared on any date, but is usually prepared at the end of an accounting period (e.g., monthly, quarterly, or annually).
• It has two columns: one for Debit Balances/Totals and one for Credit Balances/Totals.

An agreed Trial Balance provides evidence that the entries in the Journal and postings to the Ledger have been made arithmetically correctly according to the rules of double entry.

Objectives Of Preparing The Trial Balance

Preparing a Trial Balance serves several important objectives in the accounting process.

To Ascertain The Arithmetical Accuracy Of Ledger Accounts

The primary objective of preparing a Trial Balance is to test whether the debit side total equals the credit side total. If the totals of the debit and credit columns of the Trial Balance agree, it indicates that:

• Every transaction has been recorded with two aspects (debit and credit).
• The amounts debited equal the amounts credited for each transaction.
• The posting from the Journal to the Ledger has been done correctly (both aspects posted with correct amounts).
• The balancing of Ledger accounts has been done correctly.

Agreement of the Trial Balance is a strong indication of arithmetical accuracy in the posting and balancing process.

To Help In Locating Errors

If the Trial Balance does not agree (the total of debit balances does not equal the total of credit balances), it is a clear indication that one or more errors have occurred during the accounting process (journalising, posting, or balancing). The difference in the Trial Balance helps pinpoint the amount of the error, which assists in searching for the error(s). (More on types and searching of errors later).

To Help In The Preparation Of The Financial Statements

The Trial Balance serves as the basis for preparing the final financial statements: the Trading and Profit and Loss Account and the Balance Sheet.

• All revenue and expense account balances (Nominal Accounts) shown in the Trial Balance are used to prepare the Trading and Profit and Loss Account to determine Gross Profit/Loss and Net Profit/Loss.
• All asset, liability, and capital account balances (Real and Personal Accounts) shown in the Trial Balance are used to prepare the Balance Sheet, which depicts the financial position of the business.

A correctly prepared Trial Balance organises all necessary account balances in one statement, significantly simplifying the process of preparing final accounts.

Preparation Of Trial Balance

There are different methods to prepare a Trial Balance, depending on whether totals or balances from the Ledger accounts are used. The Balances Method is the most commonly used.

The general format of a Trial Balance includes:

• Name of the Company
• Title: Trial Balance
• Date as on which it is prepared
• Columns for: Account Name, Ledger Folio, Debit Amount (₹), Credit Amount (₹)

Common Format of Trial Balance:

Trial Balance of [Name of Company] as on [Date]

Methods of Preparation:

1. Totals Method:

In this method, instead of using the final balance of each Ledger account, the total of the debit side and the total of the credit side of each account are listed in the Trial Balance. Each account will thus appear twice in the Trial Balance (once with its debit total, once with its credit total).

Format (Totals Method):

This method directly verifies that total debits equal total credits for all transactions but is less useful for preparing final accounts as it doesn't show net balances.

2. Balances Method:

This is the most popular and widely used method. It lists only the final debit or credit balance of each Ledger account. An account will have either a debit balance or a credit balance (or a nil balance, which is usually omitted).

Format (Balances Method):

Same as the "Common Format of Trial Balance" shown above. Debit balances are listed in the debit column, and credit balances are listed in the credit column.

This method is convenient for preparing financial statements as it directly provides the required balances.

3. Totals-Cum-Balances Method:

This method combines the features of both the Totals Method and the Balances Method. It has four amount columns: Debit Total, Credit Total, Debit Balance, and Credit Balance.

Format (Totals-Cum-Balances Method):

In this method, the sum of the 'Debit Total' column must equal the sum of the 'Credit Total' column. Also, the sum of the 'Debit Balance' column must equal the sum of the 'Credit Balance' column. This method provides the most complete information but is more time-consuming.

Significance Of Agreement Of Trial Balance

The fundamental rule of the double-entry system ensures that the total of all debits equals the total of all credits for every transaction. Consequently, the total of all debit balances in the Ledger must equal the total of all credit balances. The agreement of the Trial Balance (i.e., the sum of the debit column equals the sum of the credit column) is considered proof of arithmetical accuracy in the books of accounts.

What Agreement Signifies:

If the Trial Balance agrees, it indicates that:

• Both the debit and credit aspects of all recorded transactions have been posted to the Ledger.
• The totals of debit and credit amounts for all transactions are equal.
• Ledger accounts have been balanced correctly.
• The balances have been correctly transferred to the Trial Balance.

What Agreement Does NOT Signify:

It is important to note that agreement of the Trial Balance does not guarantee that there are no errors in the books. It only confirms arithmetical accuracy where errors affect both the debit and credit sides equally or cancel each other out. There are certain types of errors that do not affect the agreement of the Trial Balance.

Classification Of Errors

Errors in accounting can be classified in different ways. One important classification is based on whether the error affects the agreement of the Trial Balance.

Errors Affecting Trial Balance Agreement:

These are errors where the total debit effects do not equal the total credit effects of a transaction or entry. They cause the Trial Balance totals to be unequal. Examples:

• Posting an incorrect amount to one side of an account.
• Posting to the wrong side of an account.
• Omitting to post one aspect of a transaction.
• Errors in balancing a Ledger account.
• Errors in casting (totalling) the Journal or subsidiary books.
• Errors in transferring balances from the Ledger to the Trial Balance.

Errors Not Affecting Trial Balance Agreement:

These are errors where the debit and credit effects of a transaction are incorrectly recorded but still balance each other. The Trial Balance will agree, making these errors harder to detect. These errors are often called Errors of Principle or Errors of Omission (of entire transactions).

Let's look at the types of errors based on their nature, and their impact on the Trial Balance agreement.

Errors Of Commission

These are errors due to wrong doing, wrong entry, or wrong casting. These relate to incorrectly recording amounts or incorrectly posting.

• Examples Affecting TB:
  • Posting ₹1,000 to an account as ₹100 (Error in posting amount).
  • Posting a debit entry to the credit side of an account (Error in posting on wrong side).
• Examples NOT Affecting TB:
  • Recording a transaction with a wrong amount in both the debit and credit aspects in the Journal itself (e.g., purchase of goods for ₹10,000 recorded as ₹1,000 in both debit and credit). Both sides are equally affected.

Errors Of Omission

These are errors due to failure to record a transaction, either fully or partially.

• Examples Affecting TB:
  • Omitting to post a Journal entry to one of the concerned Ledger accounts (Partial Omission).
• Examples NOT Affecting TB:
  • Omitting to record a transaction completely in the Journal (Complete Omission). If a transaction is not recorded at all, both debit and credit aspects are missing, and the Trial Balance still balances.

    Example 9.

    Sold goods on credit to Mr. Anand for ₹5,000. This transaction was completely omitted from the books.

    Answer:

    The Journal entry (Mr. Anand Dr. To Sales A/c) was never made. Consequently, neither Mr. Anand's account was debited nor Sales account credited. The Trial Balance totals remain unaffected.

Errors Of Principle

These errors occur when accounting principles are violated, typically by incorrectly classifying accounts (treating a capital expenditure as revenue expenditure or vice versa). These errors usually do not affect the agreement of the Trial Balance because the debit and credit aspects are recorded with the correct amounts, but in the wrong categories of accounts.

Examples NOT Affecting TB:

Answer:

Compensating Errors

These are errors where the effect of one error is cancelled out by the effect of another error. These errors also do not affect the agreement of the Trial Balance.

Example NOT Affecting TB:

Answer:

The agreement of the Trial Balance is a necessary check for arithmetical accuracy, but it is not a conclusive proof of accuracy. Errors not affecting the agreement require specific searching and identification.

Searching Of Errors

When the Trial Balance does not agree, it indicates the presence of errors. A systematic search procedure is required to locate these errors. The search process often starts by looking for errors that are easy to find and affect the Trial Balance totals.

Steps to Search for Errors (when TB doesn't agree):

1. Calculate the Difference:

Find the exact difference between the total of the Debit column and the total of the Credit column in the Trial Balance. This difference is the key amount to look for.

2. Divide the Difference by 2:

If the difference is divisible by 2, it might indicate an amount that has been posted to the wrong side of a Ledger account. For example, an amount of ₹500 wrongly posted to the credit side instead of the debit side will cause the debit total to be ₹500 less and the credit total to be ₹500 more, creating a difference of ₹1,000 (double the error amount).

3. Divide the Difference by 9:

If the difference is divisible by 9, it might indicate an error of transposition (reversing the order of digits, e.g., writing 52 instead of 25) or an error of slide (misplacing the decimal point, e.g., writing 100 instead of 1,000). The difference in the digits due to transposition is always divisible by 9.

4. Check the Totals:

Re-total the Debit and Credit columns of the Trial Balance carefully.

5. Check Balances Transfer:

Verify that the balances from all Ledger accounts have been correctly transferred to the Trial Balance with the correct amount and in the correct column (debit balances in the debit column, credit balances in the credit column).

6. Check Ledger Account Balances:

Re-calculate the balances of all Ledger accounts.

7. Check Posting:

Compare the entries in the Journal (or subsidiary books) with the postings made in the Ledger accounts. Check that every debit in the journal is posted as a debit in the ledger, and every credit in the journal is posted as a credit in the ledger, with the correct amount. This is often a systematic process starting from the beginning of the period.

8. Check Journal Totals/Casting:

Verify the totals of the debit and credit columns in the Journal and subsidiary books.

9. Check Original Entries:

In rare cases, you might need to check the original transactions recorded in the Journal against the source documents, but this is usually a last resort for large differences or when other checks fail.

Searching for errors can be a tedious process. The difference in the Trial Balance provides a starting point and hints, but systematic verification of steps in the accounting process is often required.

Rectification Of Errors

Once an error is discovered, it must be corrected or rectified. The method of rectification depends on when the error is discovered – before posting to the Ledger, after posting but before preparing the Trial Balance, after preparing the Trial Balance but before preparing final accounts, or in the next accounting year.

Rectification Of Errors Which Do Not Affect The Trial Balance

These errors (Errors of Complete Omission, Errors of Principle, Compensating Errors, Recording wrong amount in both aspects in Journal) do not cause the Trial Balance to disagree. Rectification requires passing a correcting Journal entry that debits and credits the affected accounts appropriately to bring them to the correct position. No Suspense Account is needed as the debit and credit sides of the correcting entry will balance.

Example 12: Error of Complete Omission (See Example 9)

Answer:

Example 13: Error of Principle (See Example 10)

Answer:

Rectification Of Errors Affecting Trial Balance

These errors cause the Trial Balance totals to disagree. The method of rectification depends on the stage of discovery.

Errors found BEFORE posting:

If an error is found in the Journal before posting to the Ledger, simply correct the entry in the Journal itself by crossing out the wrong amount/account and writing the correct one, initialling the correction.

Errors found AFTER posting but BEFORE Trial Balance preparation:

These are errors like posting wrong amount, posting to wrong side, or partial omission of posting. Correct the error in the specific Ledger account(s) affected. This might involve making an additional posting, cancelling a wrong posting, or correcting an amount. Add a note explaining the correction.

Answer:

Errors found AFTER Trial Balance preparation (or when TB agrees but error exists):

At this stage, rectification is done by passing a Journal entry (called a Rectification Entry). If the error affects only one side of an account (or only one account's balance is wrong), a Suspense Account is used.

A Suspense Account is a temporary account created when the Trial Balance does not agree. The difference in the Trial Balance is transferred to the Suspense Account (placing the difference on the side that is short) so that the Trial Balance temporarily agrees. This allows the final accounts to be prepared. When errors are found, rectification entries are passed using the Suspense Account.

Rectification Entry using Suspense Account:

The rectification entry will debit or credit the account that was incorrectly debited or credited, and the opposite entry will be to the Suspense Account.

Answer:

Rectification Of Errors In The Next Accounting Year

If errors are discovered in the next accounting year, after the books for the previous year have been closed and final accounts prepared, rectification entries must be passed. In this case, instead of affecting Nominal Accounts (which would have been closed to P&L Account), the effect of nominal accounts is routed through the Profit and Loss Adjustment Account (for errors affecting P&L) or Trading Account Adjustment Account (for errors affecting Trading A/c). However, for simplicity, it is often assumed that the impact on P&L is directly routed to Capital or P&L Adjustment Account. The Suspense Account is almost always used if the Trial Balance agreed in the previous year.

Answer:

Rectification of errors is a critical step to ensure that accounting records accurately reflect the financial position and performance of the business.