Chapter 2: Trial Balance and Balance Sheet

Introduction

By the end of this chapter, you should be able to:

• Record transactions in the general ledger using double entry, ensuring that each transaction affects at least two accounts to maintain the accounting equation (Assets=Liabilities+EquityAssets=Liabilities+Equity).

  • Why? Double-entry bookkeeping ensures accuracy and helps maintain the balance of the accounting equation.

• Balance off a set of general ledger accounts, verifying that total debits equal total credits in each account.

  • Why? Balancing ensures that all transactions are correctly recorded and that no mathematical errors exist.

• Prepare a trial balance, which is a listing of all ledger balances at a specific point in time.

  • Why? A trial balance helps to detect any mathematical errors that may have occurred in the double-entry bookkeeping system before preparing financial statements.

• Understand a simple balance sheet in vertical format, which presents a company's assets, liabilities, and equity at a specific point in time.

  • Why? The balance sheet provides a snapshot of a company's financial position at a specific point in time, helping users assess its solvency and financial health.

• Design and use spreadsheets to prepare ledger accounts, utilizing software for efficient and accurate financial record-keeping.

  • Why? Spreadsheets automate calculations and record-keeping, reducing errors and saving time.

Balancing Off Accounts and Preparing a Trial Balance

The General Ledger

• Capital, assets, and liabilities each have their own T-account recorded in the general ledger (also known as the nominal ledger), which is the central repository for all accounting transactions.

The general ledger contains three categories of T-accounts:

1. Assets

2. Capital

3. Liabilities

Trial Balance

A trial balance is a list of all the balances in the general ledger accounts, serving as a check to ensure that for every transaction, a debit recorded in one ledger account has been matched with a credit in another and forms the basis for the preparation of the main financial statements: the balance sheet and the income statement. The trial balance helps to detect any mathematical errors that may have occurred in the double-entry bookkeeping system.

• The process of preparing the list is known as extracting a trial balance.

• It lists narrative, debit, and credit columns, providing a summary of all account balances.

• Double-entry bookkeeping: If the double entry has been carried out, the total of the debit balances should always equal the total of the credit balances. This equality confirms the fundamental accounting equation: Assets=Liabilities+EquityAssets=Liabilities+Equity.

2.1.1 The Trial Balance

• To prepare a trial balance, it's necessary to determine the balance on each account by 'balancing off' the general ledger accounts.

• The trial balance is prepared by listing each closing balance from the general ledger accounts as either a debit or a credit balance. This process ensures that all accounts are accounted for and that the total debits equal the total credits.

2.1.2 The procedure for balancing off accounts

Accounts are straightforward to balance off if they consist of only one type of entry, i.e. only debit entries or only credit entries. In this case, all the account entries are simply added up to get the balance on the account.

Balancing accounts with both debit and credit entries:

1. Add up the side with the highest total.

2. Enter the larger figure as the total for both the debit and credit sides. This ensures that both sides of the T-account reflect the same total.

3. Calculate the figure that makes the smaller side add up to the larger total. Enter this figure as the 'balance carried down' (Balance c/d).

4. Enter the balance brought down (Balance b/d) on the opposite side below the total figure. The balance b/d is usually dated one day later than the balance c/d. This carries the balance to the next accounting period.

Balancing single-entry accounts:

• The single entry amount is the total as well as the balance in the account.

Edgar Edwards Example

• After balancing all general ledger accounts, a trial balance is prepared by listing all the balances (brought down balances). Instead of using the terms debit and credit the abbreviation Dr and Cr have been used as is customary.

EdgarEdwardsEdgarEdwards

Trialbalanceasat6July20X2Trialbalanceasat6July20X2

Box 2.1 For every debit there is a credit

From the trial balance it can be seen that the total of debit balances equals the total of credit balances. This demonstrates that for every transaction the basic principle of double-entry bookkeeping has been followed − for every debit there is a credit.

2.1.3 Finding a difference on a trial balance

If a trial balance does not balance, follow these steps:

1. Add up each side again. Ensure that all figures have been correctly transcribed and calculated.

2. Divide the difference by two, and see if the resulting figure is in the trial balance. It may be on the wrong side. This helps identify if a debit has been mistakenly entered as a credit, or vice versa.

3. Check if the difference divides by nine, which could indicate a transposed figure (e.g., £18 entered as £81). Transposition errors are common and easily detectable using this method.

4. Ensure every balance from the general ledger is in the trial balance. Verify that no accounts have been omitted during the preparation of the trial balance.

5. Check that every general ledger account has been correctly cast (added up). Re-total all the general ledger accounts to confirm their accuracy.

6. Go back and check every entry in the general ledger. Review all journal entries and postings to identify any discrepancies or errors.

2.2 Balance Sheet

The trial balance contains all the elements of the accounting equation:

Assets=Capital+LiabilitiesAssets=Capital+Liabilities

Assets=Capital+LiabilitiesAssets=Capital+Liabilities

Bank+Furniture+Computer=Capital+BankLoan+PayablesBank+Furniture+Computer=Capital+BankLoan+Payables

£9,150+£400+£600=£4,950+£5,000+£200£9,150+£400+£600=£4,950+£5,000+£200

£10,150=£10,150£10,150=£10,150

The balance sheet shows the total of assets balancing with the total of capital and liabilities.

Balance Sheet Formats

• Horizontal format: Assets on one side, capital and liabilities on the other. This format presents a side-by-side comparison of assets and liabilities plus equity.

• Vertical format: Assets at the top, capital and liabilities at the bottom (more conventional). This format is more commonly used and provides a clear, top-to-bottom view of the financial position.

The balance sheet is normally produced at the end of each trading or financial year and is a snapshot of the financial position of the business on the last day of the financial year.

Edgar Edwards Enterprises Balance Sheet Example

EdgarEdwardsEnterprisesEdgarEdwardsEnterprises

Balancesheetasat6July20X2Balancesheetasat6July20X2

Balance Sheet Structure

The balance sheet is divided into two halves, each with the same total.

Top Half: Assets

• Non-current assets: Held for more than one year.

  • Tangible: Physical form (land, buildings, furniture, vehicles).

  • Intangible: No physical form but provide future benefits (goodwill, patents, copyrights, brand names).

• Current assets: Expected to be held for less than one year. Listed in order of liquidity.

  • Inventory

  • Receivables

  • Prepayments

  • Cash at bank

  • Cash in hand

Bottom Half: Capital and Liabilities

• Capital: Owner's investment in the business.

  • Capital introduced

  • Profits and losses

  • Drawings: Monies or goods taken out by the owner for personal use (debit drawings,