What is a trial balance, and how does a trial balance work? Let me show you an example of what a trial balance looks like, and explain why a trial balance is a useful accounting tool that has already been in use for centuries!

⏱️TIMESTAMPS⏱️
0:00 Introduction to trial balance
0:16 Trial balance in the accounting process
0:36 Trial balance purpose
1:13 Recording transactions
1:34 Trial balance definition
1:53 Trial balance example
3:21 Trial balance vs balance sheet
3:58 Trial balance and error correction

Let’s start off with identifying how trial balances fit into the accounting process. The first step is to identify the transactions that need to be recorded. You then record the journal entries, and prepare T-accounts. The trial balance is the next step, right in between preparing the T-accounts and preparing the financial statements. A trial balance allows you to check for mathematical errors (is the sum of the debits equal to the sum of the credits), and check account balances versus expectations (if you usually have a balance of around $100,000 in Accounts Receivable, and now you have $10 million, you want to check the journal entries making up that balance).

Not everything that happens in a company is a transaction that needs to be recorded. For example, saying good morning to the managing director, or taking customers on a tour of the site, might be useful things to do, but don’t need a journal entry. An example of an event that does need to be recorded is purchasing goods from a supplier on credit. The journal entry for this is debit inventory, credit accounts payable. Or if you want to visualize that, put the debit amount on the left of the inventory T-account and put the credit on the right of the accounts payable T-account. A trial balance is a listing of all ledger accounts along with their respective debit or credit balances for the period. Let’s take the journal entries from the “income statement versus balance sheet” video (that I encourage you to watch first by clicking on the link) to prepare a trial balance.

A trial balance covers a certain accounting period, in this case year 1 of a brand new company, and lists the ledger accounts with their respective debit or credit balance.

A trial balance is not the same as a balance sheet. A trial balance lists balance sheet as well as income statement accounts.

What can we conclude now that our trial balance is balancing? Well… if the trial balance fails to balance, then we know that an error has occurred and must be located. If the trial balance is balancing, then either no error has occurred or an error has occurred that is more difficult to detect. For example, maybe the debit and the credit in a journal entry were swapped. Or a journal entry may have been posted to the wrong account. Or a transaction has not been recorded altogether. Or a journal entry was posted for incorrect amounts. Or a journal entry was posted to the wrong account type. Careful review of the trial balance, checking for example whether all asset and expense accounts have debit balances, and all liabilities, equity and revenue accounts have credit balances, could help you detect some of these.

We have moved from the days of manually writing our journal entries into large ledger books, to electronic posting of journal entries into large databases. Every accounting system that I have ever used has a validation rule that checks whether a journal entry is balanced, so the need to check whether a trial balance is balancing between debits and credits has decreased. It’s still worthwhile to know how a trial balance works, as it can help you detect errors in an early stage.

The trial balance: a listing of all ledger accounts along with their respective debit or credit balances for the period.

Philip de Vroe (The Finance Storyteller) aims to make strategy, #finance and leadership enjoyable and easier to understand. Learn the business and #accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!