Difficulty level: Beginner
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Trial Balance and financial statement
We have talked about creating journal entries and posting to general ledgers. In ancient times, when record keeping used to be done by hand, accountants needed an additional step to ensure that all debits equaled credits. It is difficult to see this using the ledger alone. As a result, the trial balance was used to meet this need.
The trial balance lists every ledger account and its balance. If the debit does not equal the credit, the accountant knows something is wrong and he or she needs to search for an error.
Today, where most businesses use computers for their accounting, the trial balance is used to scan for possible abnormalities in the accounting record. For instance, if supplies expenses is 50% lower than usual, more investigation might need to be done to see why. The problem might be due to an error in recording a transaction or even worse a transaction was missed and never entered in the books.
Adjusted trial balance
After the accountant has checked to make sure everything is ok with the trial balance, the adjusting entries discussed in the previous lesson are recorded in the books. For instance, an adjustment is made for supplies used or expired rent in the accounting period.
To adjusting entry will have to be posted to the general ledger from the journal entry. This is then transferred to the adjusted trial balance.
Financial statement
The adjusted trial balance provides the information to prepare the financial statement. In previous units, we prepared our financial statements using the accounting equation. This is fine as long as you have just a few transactions. But as your transactions grow, you need a system that can handle the additional data you need to deal with.
The sequence we will be using for the rest of the course will be as follows:
- Make journal entry
- Post to general ledger
- Prepare trial balance
- Make adjusting journal entries
- Post to general ledger
- Prepare adjusted trial balance
- Prepare financial statement
- Close books
- Post-closing trial balance
Closing the books
Closing the books moves temporary accounts like revenues, expenses and dividends into the retained earnings account.
Below is how to close revenue, expense and dividend to retained earnings:
- Credit expense and Debit Retained Earnings
- Credit dividend and Debit Retained Earnings
- Debit Revenue and Credit Retained Earnings
For instance to record cash revenue we debit cash and credit revenue. To close revenue, we will debit revenue and credit retained earnings.
Once the books are closed, the final step is to prepare the post-closing trial balance. The post-closing trial balance will not show any totals for revenue, expenses or dividends as they will be closed to retained earnings.
Click here to read more about the post-closing trial balance
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