Numerous transactions take place in business everyday. They are first recorded in books of original entry - Journal or one of its sub-divisions. Then, they are posted to the appropriate accounts in the ledger. Each ledger account is balanced periodically so as to ascertain the net effect of various transactions posted therein.
In the process, some accounts may get closed; the final accounts are prepared for ascertaining the profit or loss and the financial position of the business. The quality and reliability of the results obtained depend on the correctness of the entries made in various books of accounts and their ledger posting. Hence, it is necessary to ascertain the accuracy of these entries and ledger postings before you proceed with the preparation of final accounts.
For this purpose, you prepare a statement called Trial Balance, which shows balances of all the ledger accounts. The names of each account having debit balances are shown in the debit column and if it shows a credit balance, the amount is entered in the credit balances column. The total of the debit balances column must tally with the total of the credit balance column, because for every debit there is a corresponding credit and vice versa. When the two totals tally, it is considered as a preliminary proof of the arithmetical accuracy of the accounts. It is an assurance that entries in the journal and posting into ledger have been correctly done and that equality between debits and credits has been maintained throughout. However, if the two totals do not tally it implies that there are some errors in the books of accounts.
Objectives of Preparing Trial Balance
1. To check arithmetical accuracy: With the help of trial balance you can identify the arithmetical error, because in such a situation the trial balance will not agree. Under such situations it is assumed that some errors have been committed. After identifying such errors the same are rectified.
2. To prepare final accounts: Trial balance becomes the basis of preparing final accounts. If you do not prepare trial balance and just start preparing final accounts, it may be possible that you forget to record some transactions that were not recorded while preparing the final accounts because information about the same was not available at that time.
3. Comparative study of each account: Trial balance helps in comparing the present balance of an account with the previous period balance. By preparing trial balance, you can estimate whether closing balance of accounts will increase or decrease within two accounting periods. It can also be used as a tool to decide whether there is need to decrease the rate of depreciation for showing improved profit position.
4. To make financial budget: Previous years trial balance figures are also helpful to estimate the future amount. You can make different financial budgets with the help of trial balance.
Limitations of Trial Balance
- As there are certain errors which are not disclosed by a trial balance, it is not a conclusive proof of the accuracy of accounts.
- A trial balance gives only condensed information of each account.
- It does not give the information about the profit or loss made by the business in the accounting period.
- If trial balance is not prepared accurately, the final accounts prepared from such a trial balance would not be reliable.
- It does not ensure that all the transactions have been actually recorded in the subsidiary books.
- It is prepared only by those enterprises which make use of double entry system.