An adjusted trial balance is a foundational component of business accounting. While the adjusted trial balance is not by itself a financial statement, it provides all the data needed to create the 3 most important financial statements: income statements, balance sheets, and cash flow statements.
Accounting software has automated how most small businesses create trial balances, but all small business owners should understand how trial balances work—and why they’re so vital to accounting. Even if you have an accountant on staff, you should appreciate the basics of bookkeeping.
What Is an Accounting Cycle?
Before software fundamentally changed how accounting is done for individuals and businesses of all sizes, bookkeeping had to be done by hand in physical journals and ledgers. This manual process utilized a process known as the accounting cycle. The accounting cycle identifies, records, and analyzes each accounting event of a business, whether this event is a sale, the purchase of a vehicle, or the payment of interest.
The accounting cycle begins the moment a financial transaction occurs and ends when the transaction is recorded in a company’s financial statements.
“Every accounting period ends by making any necessary adjusting entries and closing out revenue and expense accounts,” notes SLC Bookkeeping. “Each accounting period begins by making any necessary reversing entries and carrying over asset, liability, and owner’s equity balances. Closing out and carrying over certain account balances is what allows you to measure your profits and losses year-over-year and to view your financial status at a particular point in time.”
The most important form of the accounting cycle is the adjusted trial balance, which utilizes a legendary bookkeeping process called general ledger accounting.
Bookkeepers will typically spend most of their time in the accounting cycle on 3 tasks: creating an unadjusted trial balance, adjusting entries, and preparing the resulting adjusted trial balance.
What Is General Ledger Accounting?
General ledger accounting is the process of recording every single financial transaction that a business conducts twice: once as a credit and once as a debit. Another way to think of this process, known as double-entry accounting, is a method of recording each transaction by how it impacts both your cash inflows and cash outflows.
Double-entry accounting was invented around 500 years ago and is a foundational element to our modern economic system all these centuries later.
Each transaction is a debit to 1 account and a credit to another—a debit for when money goes into the account and credit for when the money flows out of an account. If your business buys an $11,000 car with cash, you would credit your “Cash” account by $11,000 and debit your “Business Vehicle” account by $11,000 since you purchased $11,000 worth of car. All these transactions are recorded as journal entries in your ledger, and because everything is recorded twice, all your credits and debits should equal out.
The process of recording everything twice can seem counterintuitive at first—but it will make sense with practice. Some very small and simple businesses might be able to use a single entry accounting method, but the vast majority of businesses should use the double-entry method.
What Is a Trial Balance?
A trial balance is a bookkeeping worksheet that compiles all the ledgers of a business and ensures that the credit and debit columns are equal—that is, both credits and debits balance. Trial balances are formulated on a regular basis, typically when a financial reporting period comes to an end.
While a general ledger records every financial transaction in every account, a trial balance is only concerned with the account totals.
The first step in preparing a trial balance is creating the unadjusted trial balance: a record of all account totals. In theory, every transaction is recorded twice as both a credit and debit, so the credit and debit total columns of your accounts should equal each other.
“A trial balance is a listing of a company’s accounts and balances,” John Freedman writes for the Houston Chronicle. “This report may not be the most exciting output of a small business accounting system, but it gives the user a full glimpse of the company’s business activity over the last year. While the format of the trial balance is pretty standard, by understanding what will remain the same and what changes are ahead, small business owners can create a trial balance that is standard in practice.”
It would be great if the first shot at an unadjusted trial balance results in totally balanced accounts, but this is probably not the case. Most likely, errors will need to be identified and entries will need to be corrected. Through this process, an unadjusted trial balance becomes an adjusted trial balance.
What Is Included in a Trial Balance?
A trial balance includes all the totals from your general ledger accounting for a specified time period. The total of each account is included. For each account, you should assign a number and description (like cash, accounts receivable, taxes, etc.). In another column, record the balance amount of the credits and debits for each account.
A Trial Balance Example
Let’s say the florist company Flowers, Inc. is creating a trial balance for the year. Their cash, rental expenses, and office supply accounts all increased in the chosen time period. These amounts would be recorded in the debit column. Flowers, Inc. also made revenue through floral sales and received an investment from its owner, which would be marked in the credit column. Both columns need to equal each other.
How Do You Prepare a Trial Balance?
From your general ledger, record and organize all your accounts on your trial balance. For each account, record if the account total was a credit or debit.
The total credits and debits for your accounts should be equal. If they aren’t balanced, you’ll need to adjust your entries. This is normal—and it’s much easier to make corrections at this point than after the financial statements are created.
“The purpose of this trial balance is to find and correct any errors prior to the preparation of the financial statements,” explains accounting expert Ed Becker. “If the totals do not equal, the error can be rectified immediately. This is a very important step in the preparing of financial statements—if errors are found later, it is a major task to redo all the financial statements.”
What Is an Adjusted Trial Balance?
To create an adjusted trial balance, start with the unadjusted trial balance. If your credit and debit columns are not equal, you’ll have to identify the error within your general ledger. This means that some transactions were not recorded accurately twice.
This process is known as “correcting entries,” and it must also be recorded in the general ledger. If you discovered a $100 bill that was never recorded, you would create a correcting entry that debits your accounts receivable $100 and credits your accounts payable $100. You should include a note that you are making a correction with each entry.
Once correcting entries are completed, return to your unadjusted trial balance. Noting any adjustments made to accounts, record your credit and debit column by account. These columns should now balance.
How Do I Know if My Trial Balance Is Correct?
If the debit and credit columns are equal on your adjusted trial balance, then your trial balance is mathematically correct.
However, a trial balance can balance but still not be correct. This occurs if transactions are missing or recorded wrong but in a way that balances.
“A trial balance does not find every error. If something was incorrectly entered but still has balanced debit and credit, that error will not be discovered in the trial balance,” Becker continues. “It also will not reveal if transactions were not recorded because the credits and debits will still balance. It is imperative that transactions be correctly entered or recorded in the ledger accounts each and every time.”
Keeping your books correct is necessary both for understanding your financial health and staying on the right side of the law. Assuming all transactions have been recorded correctly, a balanced trial balance is a correct trial balance.
Creating Financial Documents From Your Adjusted Trial Balance
Income statements, balance sheets, and cash flow statements are the 3 most important financial statements for business accounting. All utilize data from your adjusted trial balance, which is why creating a trial balance is the first step in financial reporting.
“If all adjusting entries have been made and a trial balance done, preparing financial statements is really just a matter of putting the trial balance amounts onto properly formatted statements,” suggests Mike Enright of firm Wolters Kluwer.
Fixing errors is challenging once a financial statement is created, which is why it’s important to locate any accounting issues while creating your adjusted trial balance.
- The revenue and expense account sections of your adjusted trial balance are used to create an income statement, also known as a profit and loss (P&L) statement.
- The assets, liabilities, and shareholders’ equity account sections are used to create your balance sheets.
- Accounts that interconnect with your cash account are used to develop a cash flow statement.
Even when using software to generate this information, you should understand why an adjusted trial balance is so fundamental to accounting and how information on your trial balance fills these financial statements.