Chapter 3 - Trial Balance and Financial Statements Flashcards
Trial Balance
A trial balance checks the arithmetic accuracy of the double entry in the ledger.
It is a formal statement of the balances, or running total, of every individual account in all the ledgers (nominal, sales and purchase).
It must also include the cash book accounts: bank and cash.
The importance of the information in the ledger accounts
- to know how much is owing/owed
- how much cash the firm has
- total of purchases and sales revenue
- total expenditure
The construction of the trial balance
Includes balances of the all the ledgers.
Debit balances are placed in the debit column, and credit balances are placed in the credit column.
After these 2 columns are totalled, totals should be the same.
Accounting equation for trial balance
E + A (D) = L + I + C (C)
Expenditure + Assets are debits
Liabilities + Income + Capital are credits
Trial Balance adds up
If both debit and credit columns in the trial balances come to the same amount, it means there are no arithmetic errors were made, but it doesn’t mean no errors were made.
Causes if arithmetic errors
- a figure omitted from one of the sides of the accounts (debit or credit missing from the double entry)
- 2 credit or 2 debit entries for the same transaction
- over or under casting (incorrect total of accounts)
- reversal or transposition of figures included once (ex. 23 instead of 32)
- a ledger account balance omitted from the trial balance
- figures entered in the wrong side of the trial balance
Limitations of a trial balance
Certain types of errors are not revealed in a trial balance.
Types of error not revealed in a Trial Balance
Error of commission Error of principle Error of omission Error of original entry Complete reversal of entries Compensating error Duplication error
Types of error not revealed in a Trial Balance
Error of commission
1 amount entered in the incorrect account (incorrect customer for instance).
Trial balance will agree, because the amounts are correct, but one of the entries is in the wrong account.
This error will have no effect on the financial statements produced, because they are of the same type (example above, 2 customers are both sales ledger)
Types of error not revealed in a Trial Balance
Error of Principle
1 amount entered in the incorrect class of account (example, when an expense entry has been added in an asset entry).
The correct debit and credit entries have been made, but in the wrong account.
The trial balance will not be affected, but the it will affect the figures in the financial statements.
Types of error not revealed in a Trial Balance
Error of Omission
When a transaction has not been entered in the accounts at all.
Types of error not revealed in a Trial Balance
Error of original entry
When the wrong figure is taken from the source document, and then recorded incorrectly in both accounts.
(example, invoice is £250, but was entered at £200)
Types of error not revealed in a Trial Balance
Complete reversal of entries
The correct figures have been posted to the incorrect side of both ledger accounts.
Example, a cheque from a customer is incorrectly credited in the bank, and debited in the customer account.
Types of error not revealed in a Trial Balance
Compensating error
2 or more errors of the same amount cancel each other out.
Example:
Sales revenue has been overcast by £200 (credit) and the purchases account was also been overcast by £200 (debit).
Overcasting is incorrectly adding up, so the amount is actually higher than it should be
Types of error not revealed in a Trial Balance
Duplication error
When a transaction is added to the ledger more than once.
For example, sale to customer is entered both in the customer account and the sales revenue twice, for exactly the same value.
Procedures for the correct of errors
Errors should not be just crossed out, as it is unacceptable for auditors, besides computerised systems will prevent that from being possible, in order to prevent fraud.
The correct way is to enter additional double entries in the relevant accounts to fix them. This applies both ti arithmetic and non-arithmetic errors.
Correct an error is fine and it will happen. Concealing an error is not acceptable.
Correcting an error of commission
Example: heating charge of £150 was incorrectly entered in the insurance account.
The insurance account needs a credit to reduce this entry; and the hearting account needs a debit to increase its balance.
DR £150 Heating
CR £150 Insurance
Correcting an error of principle
Example: the cost of £250 for an office desk was entered in repairs and maintenance, which was incorrectly debited. So it will need to be credited to cancel the original incorrect entry
Double entry:
CR £250 Repairs and maintenance
DR £250 Office Equipment
Correcting an error of omission
Example: a sales invoice of £600 (before VAT) wasn’t entered in the books at all.
In this case, the double entry just needs to be added.
Double entry:
DR £720 custoemr account
CR £600 sales revenue
CR £120 VAT
Correcting an error of original entry
Example: electricity invoice of £530 was entered in the accounts as £330.
Which means there is a difference of £200 on both sides of the double entry.
Double entry:
DR £200 Electricity account
CR £200 supplier account (N Power i.e)
Correcting an error of complete reversal of entries
Example: A cheque of £300 received was credited to the bank account and debited to the customer’s account.
In order to correct this error, it is necessary to double the amount of the original error.
Double entry:
DR £600 in the bank account (to remove the incorrect credit and enter the correct amount to be debited)
CR £600 in the customer account 9to remove the incorrect debit and credit the correct amount)
Correcting an error of compensating errors
Example: both the purchase and the sales accounts were overstated by £300.
DR £300 in the sales account
CR £300 in the purchases account
The Journal
The Journal is important, as it clarifies that it’s not simply enough to correct the double entry transactions, as they would be undocumented.
Thought the majority of the entries have a documentary evidence (invoices, credit notes, cheques, etc), it is also important to have evidence that supports the correct of the errors. this is prevent fraudulent entries on the pretext they are to correct and error.
Therefore the Journal serves as evidence of the error correction. Each entry should have a unique entry number, and an explanation for the reason for the correction (narrative).
Journal entries should only be written with the consent of a senior manager.
Journal entry examples (error of omission correction)
Invoice of £720 wasn’t entered at all:
The Journal
Date Account and narrative DR CR
Jan-10 Customer account name 720
Sales Revenue 600
Tax account 120
to correct error of omission: invoice was not
entered in the accounts
Journal entry examples (error of original entry)
Electricity invoice of £530 entered in the accounting system as £330:
The Journal
Date Account and narrative DR CR
Jan-10 Electricity (NL) 200
Supplier account 200
to correct error of original entry: invoice of £530 entered as £330
Journal entry examples (compensating error)
Sales and purchases have been both been overcast by £300
The Journal
Date Account and narrative DR CR
Jan-10 Sales Revenue (NL) 300
Purchases (NL) 300
to correct compensating error: sales and purchases both overcast by £300
The Suspense Account (NL) and the correction of arithmetical errors
If the Trial Balance doesn’t agree, that means there are arithmetical errors.
Because the errors may take time to be found, the suspense account works as a ‘holding’ account, which is used while the errors are being found.
The difference between the debit and the credit is posted in the Suspense Account
Example:
Trial Balance
DR CR
Original Amount 3,511 3,505
Suspense Account 6
The suspense account will be opened with the £6 credit which would make the Trial Balance agree
Suspense Account example
Trial Balance
DR CR
Original Amount 3,511 3,505
Suspense Account 6
The suspense account will be opened with the £6 credit which would make the Trial Balance agree.
Suspense Account (NL)
Date Details DR CR Balance
Dec 31 Trial Balance 6 6CR
Though it is only a £6 difference, there may have been more than 1 error.
Suspense Account example
If the 2 errors that caused the £6 difference above were:
- £102 cheque entered in the bank, but not in the customer account —–> because customer account wasn’t credited, suspense account must be debited
- £96 invoice was entered in the supplier’s account, but not in the heating and lighting ——> because heating and lighting was not debited, suspense account must be credited
Corrections in suspense account
Suspense Account (NL)
Date Details DR CR Balance
Dec 31 Trial Balance 6 6CR
Feb 15 Customer account 102
Feb 15 Heating 96 —
Customer account needed to be credited, as they paid and entry wasn’t added. So suspense account was debited.
Heating account needed to be debited, as as invoice wasn’t added. So suspense account was credited.
Trial Balance and Suspense Account
If the error came up in the Trial Balance, it will need to be recorded in the suspense account. If it didn’t come up in the trial balance, it won’t be recorded in the trial balance.
