The Trial Balance

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The Trial Balance

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Title: The Trial Balance

1
The Trial Balance

In order to check that for each debit entry made
a corresponding credit entry is made, we prepare
what is known as a trial balance.

2
THE TRIAL BALANCE

Remember our worked example from last week.

3
WORKED EXAMPLE

MAY 2009
1 Bought goods on credit 68 from D. Small.
2 Bought goods on credit 77 from A. Lyon Son.
5 Sold goods on credit to D. Hughes for 60.
6 Sold goods on credit to M. Spencer for 45.
10 Returned goods costing 15 to D. Small.
12 Bought goods for cash 100.
19 M. Spencer returned goods to us (the
business) which had cost him 16.
21 Goods were sold for cash 150
22 Paid cash to D. Small amounting to 53.
30 D. Hughes paid the amount owed by him to the
business 60 in cash.
31 Bought goods on credit 64 from A. Lyon Son.

4
WORKED EXAMPLE

RETURNS OUTWARDS A/C
2009
May 10 D. Small 15

5
WORKED EXAMPLE

RETURNS INWARDS A/C
2009
May 19 M. Spencer 16

6
WORKED EXAMPLE

M. Spencer A/C
2009 2009 May 6 Sales A/C
45 May 19 Returns In. 16

7
WORKED EXAMPLE

SALES A/C
2009
May 5 D. Hughes 60
6 M. Spencer 45
21 Cash 150

8
WORKED EXAMPLE

D. Small A/C
2009 2009
May 10 Returns Out. 15 May 1Purchases 68
May 22 Cash 53

9
WORKED EXAMPLE

CASH A/C
2009 2009
May 21 Cash 150 May 12 Purchases 100
May 30 D. Hughes 60 May 22 D. Small
53

10
WORKED EXAMPLE

D. Hughes A/C
2009 2009 May 5 Sales A/C
60 May 30 Cash 60

11
WORKED EXAMPLE

PURCHASE A/C
2009
May 1 D. Small 68
2 A. Lyon 77
12 Cash 100
31 A. Lyon 64

12
WORKED EXAMPLE

A. Lyon Son A/C
2009
May 1 Purchases 77
May 31 Purchases 64

13
WORKED EXAMPLE

We will now balance off these accounts.

14
WORKED EXAMPLE

PURCHASE A/C
2009 2009
May 1 D. Small 68
2 A. Lyon 77
12 Cash 100
31 A. Lyon 64
May 31
Bal c/d 309
309 309
June 1 Bal b/d 309

15
WORKED EXAMPLE

SALES A/C
2009
May 5 D. Hughes 60
6 M. Spencer 45
21 Cash 150
May 31 Balance c/d 255
255 255
June 1
Balance b/d 255

16
WORKED EXAMPLE

RETURNS OUTWARDS A/C
2009 2009
May 10 D. Small 15
May 31 Balance c/d 15
15 15
June 1
Balance b/d 15

17
WORKED EXAMPLE

RETURNS INWARDS A/C
2009 2009
May 19 M. Spencer 16
May 31 Balance c/d 16
16 16
June 1 Balance b/d 16

18
WORKED EXAMPLE

D. Small A/C
2009 2009
May 10 Returns Out. 15 May 1Purchases 68
May 22 Cash 53
68 68

19
WORKED EXAMPLE

A. Lyon Son A/C
2009 2009
May 1 Purchases 77
May 31 Purchases 64
May 31 Balance c/d 141
141 141
June 1 Bal. b/d 141

20
WORKED EXAMPLE

D. Hughes A/C
2009 2009 May 5 Sales A/C
60 May 30 Cash 60
60 60

21
WORKED EXAMPLE

M. Spencer A/C
2009 2009 May 6 Sales A/C
45 May 19 Returns In. 16
May 31 Balance c/d 29
45 45
June 1 Balance b/d 29

22
WORKED EXAMPLE

CASH A/C
2009 2009
May 21 Cash 150 May 12 Purchases 100
May 30 D. Hughes 60 May 22 D. Small
53
May 31 Balance c/d 57
210 210
June 1 Balance b/d 57

23
If a trial balance was drawn up using the closing
account balances, it would appear as follows

Trial Balance as at 31 May 2009
Debit (Dr) Credit (Cr)
Purchases 309
Sales 255
Returns outwards 15
Returns inwards 16
A. Lyon Son 141
M. Spenser 29
Cash 57
411 411

24
THE TRIAL BALANCE

The trial balance always has the date of the last
day of the accounting period to which it relates.
It is a snapshot of the balances on the accounts
at that time.
It is normal practice to prepare a trial balance
at the end of an accounting period, prior to
preparing a profit and loss account and balance
sheet.
We will study these two statements next, but
before this, let us consider what a trial balance
actually tells us?

25
THE TRIAL BALANCE

Many students assume that when the trial balance
balances, the entries in the account MUST be
correct.
THIS ASSUMPTION IS INCORRECT.
If you completely reverse the entries, i.e. debit
when you should credit and credit when you should
debit, the trial balance will still balance.

26
If you completely reverse debits and credits, the
trial balance would appear as follows

Trial Balance as at 31 May 2009
Debit (Dr) Credit (Cr)
Purchases 309
Sales 255
Returns outwards 15
Returns inwards 16
A. Lyon Son 141
M. Spenser 29
Cash 57
411 411

27
THE TRIAL BALANCE

Note that the trial balance will still balance.
A number of other errors will not be revealed by
a trial balance.
We will study these in week 7.
Let us now return to the profit and loss account,
and the balance sheet.

28
TRADING AND PROFIT AND LOSS ACCOUNTS

The main reason why people set up in businesses
is to make profits. If however, a business is
not successful, it will incur losses.
Knowing what profits are being made helps
businesses to do many things. Can you suggest
what these might be?

29
Trading and Profit and Loss Accounts

In a previous lecture, we introduced the
distinction between gross profit and net profit.
For a retail company (that is a business which
buys goods and then resells them), GROSS PROFIT
is the excess of sales revenue (income from the
sale of goods) over the cost of goods sold. It
is calculated in what accountants refer to as the
TRADING ACCOUNT.

30
Trading and Profit and Loss Accounts

NET PROFIT is calculated in the PROFIT AND LOSS
ACCOUNT and consists of the gross profit PLUS any
revenue other than that for sales, such as
commissions received, LESS expenses, that is the
costs incurred other than the actual cost of the
goods sold.
REMEMBER, FOR THE MINUTE, WE ARE ONLY CONSIDERING
A RETAIL BUSINESS, THAT IS A BUSINESS THAT BUYS
GOODS AND RESELLS THEM.

31
Trading and Profit and Loss Accounts

Before preparing a trading, and profit and loss
account (usually referred to as a Profit and Loss
Account), it is usual to draw up a trial balance.
The Trial Balance for a retail trader B. Swift,
after the completion of his first year in
business, is provided below.

32
B. SwiftTrial Balance as at 31 December 2005

Dr Cr
Sales 3,850
Purchases 2,900
Rent 240
Lighting expenses 150
General expenses 60
Fixtures and Fittings 500
Debtors 680
Creditors 910
Bank 1,510
Cash 20
Drawings 700
Capital 2,000
6,760 6,760

33
Trading and Profit and Loss Accounts

Note that these balances have at this stage been
calculated, but the individual accounts have NOT
BEEN BALANCED OFF.
The reason for this is that some of the balances
are going to be transferred to a Trading account
and others transferred to a Profit and Loss
account, as a set of financial statements is
going to be prepared for the year. The balances
remaining after this, will be shown in the
Balance Sheet.
Dont worry too much at this stage about the
different treatment of balances. The reasons for
the different treatments will soon become clear.

34
Trading and Profit and Loss Accounts

It would be easier if all the goods bought during
a year, were also sold during the year. However,
it is generally the case that some goods
purchased will not have been sold, that is the
business will have a closing stock of goods.
Note that at this stage there is no record in the
accounting books of the value of this unsold
stock.
The only way that Swift can find this figure is
by stocktaking at the close of business on 31
December 2005, that is, make a list of all unsold
goods. Normally these goods would be valued at
cost, however there may be occasions when they
are not. We will study this further in week 6.

35
Trading and Profit and Loss Accounts

B. Swift has calculated the value of his closing
stock at 300.
Is this closing stock an asset or a liability?

36
Double entry to record closing stock

STOCK A/C
2005 2005
Dec 31 Trading A/c 300
Dec 31 Balance c/d 300
300 300
2006
Jan 1 Balance b/d 300

37
Trading and Profit and Loss Accounts

Note that the closing stock for the period (in
this example one year) is always brought forward
as the opening stock for the next period.
It must be remembered that we are concerned here
with the very first year of trading, when there
is no opening stock.
We will study how to account for stock in the
later years of a business in subsequent lectures.

38
Double entry to record closing stock

TRADING A/C
2005 2005
Dec 31 Stock 300

39
Trading and Profit and Loss Accounts

We can now proceed to CLOSE OFF the sales and
purchases accounts, by transferring the balances
in them to the trading account, in order to
determine the gross profit for the period (in
this example, for the year).
The balance in the trading account is also CLOSED
OFF, by transferring the gross profit to the
profit and loss account.

40
Closing off the Sales Account

Sales A/c
2005 2005
Dec 31 Bal. 3,850
Dec 31 Trading A/c 3,850
3,850 3,850

41
Closing off the Purchases Account

Purchases A/c
2005 2005
Dec 31 Bal. 2,900
Dec 31 Trading A/c 2,900
2,900 2,900

42
What does the trading account look like now?

TRADING A/C
2005 2005
Dec 31 Purchases 2,900
Dec 31 Sales 3,850
Dec 31 Stock 300

43
Closing off the trading account

TRADING A/C
2005 2005
Dec 31 Purchases 2,900
Dec 31 Sales 3,850
Dec 31 Stock 300
Dec 31 Gross Profit
to PL A/c 1,250
4,150 4,150

44
Trading and Profit and Loss Accounts

The costs used up for the year, in other words
the expenses (remember, the cost of sales have
already been dealt with in the trading account),
are transferred to the Profit and Loss account.
Also, any revenue account balances, other than
sales (which have already been dealt with in the
trading account), are transferred to the Profit
and Loss account (remember, these are credit
balances, WHY?).
In the case of B. Swift, there are no such
revenues.

45
Closing off the Rent Account

Rent A/c
2005 2005
Dec 31 Bal. 240
Dec 31 PL A/c 240
240 240

46
Closing off the Lighting expenses Account

Lighting expenses A/c
2005 2005
Dec 31 Bal. 150
Dec 31 PL A/c 150
150 150

47
Closing off the General expenses Account

General expenses A/c
2005 2005
Dec 31 Bal. 60
Dec 31 PL A/c 60
60 60

48
Profit and Loss Account

2005 2005
Dec 31
Trad. A/c
Gross Profit 1,250
Dec 31 Rent 240
Dec 31 Lighting 150
Dec 31 General 60
Dec 31 Net Profit
Capital A/c 800
1,250 1,250

49
Trading and Profit and Loss Accounts

You now have all the information you need to
prepare the financial statement called the
Trading, Profit and Loss Account, for B. Swift
for the year ended 31 December 2005.
It is presented as follows
Note that it is possible to prepare a Trading,
Profit and loss account, without completing all
of the double entry accounts. We will do this
when we another question. However, it is
important for your future studies that you
understand the double entry procedures.

50
B. SwiftTrading, Profit and Loss AccountYear
Ended 31 December 2005

Sales 3,850
Less Cost of Sales
Purchases 2,900
Closing stock ( 300)
(2,600)
GROSS PROFIT 1,250
Less EXPENSES
Rent 240
Lighting 150
General 60
( 450)
NET PROFIT 800

51
Effect upon the capital account

The net profit generated will increase the amount
the business owes to the owner.
Conversely, the amount of money taken out of the
business by the owner (that is, drawings) will
decrease the amount the business owes to the
owner.
Periodically (in this case annually), the impact
of profit and drawings, will be transferred to
the capital account.
Let us finish the account transfers for B. Swift.

52
Closing off the Drawings Account

Drawings A/c
2005 2005
Dec 31 Bal. 700
Dec 31 Capital A/c 700
700 700

53
Closing off the Capital Account

Capital A/c
2005 2005
Dec 31 Drawings 700 Dec 1 Bal.
b/d 2,000
Dec 31 P L A/c 800
Dec 31 Balance c/d 2,100
2,800
2,800
2006
Jan 1 Bal. b/d 2,100

54
The Balances still in the books of the business

Not all of the items in the trial balance have
been CLOSED OFF.
The remaining balances are assets or liabilities
and of course capital, they are NOT revenues or
expenses.
These balances will be used when the balance
sheet is prepared.
The Trial Balance, after CLOSING OFF ACCOUNTS
relevant to the Trading, Profit and Loss Account
is shown below

55
B. SwiftTrial Balance as at 31 December 2005

Dr Cr
Fixtures and Fittings 500
Debtors 680
Creditors 910
Bank 1,510
Cash 20
Capital 2,100
Stock 300
3,010 3,010

56
The Balances still in the books of the business

We will use this trial balance to look at the
balance sheet for B. Swift, after his trading,
profit and loss account has been prepared.

57
B. SwiftBalance Sheet as at 31 December 2005

FIXED ASSETS
Fixtures and Fittings 500
CURRENT ASSETS
Stock 300
Debtors 680
Bank 1,510
Cash 20
2,510
CURRENT LIABILITIES
Creditors ( 910)
NET CURRENT ASSETS 1,600
2,100
LONG TERM LIABILITIES ( 0)
CAPITAL
Capital introduced 2,000
Net Profit 800
2,800

58
THE BALANCE SHEET

You should remember from week 1 the meaning of
the terms, fixed assets, current assets, current
liabilities and net current assets.
Long-term liabilities are items that have to be
paid for more than a year after the balance sheet
date. Examples might included, long-term bank
loans.
Although, B. Swift has no long-term liabilities,
we have included the heading to illustrate where
in the balance sheet such liabilities would be
shown. If a business did not have any long-term
liabilities, the heading would not usually be
included.

59
THE BALANCE SHEET

The figure for each item within each category
should be shown and a total for the category
produced. An example of this is the 2,510 total
of current assets. The figure for each current
asset is listed and the total is shown below.
Note that it is convention to list each current
assets in the order in which they can be
converted into cash, i.e. the one that in general
takes the longest to convert into cash (stock),
is usually shown first and so on.

60
THE BALANCE SHEET

You do not write the word account after each
item.
The owner/s will be very interested in the
capital figure, as it represents the amount of
money the business owes them. For this reason,
the full details of movements in the capital
account are provided, i.e. the opening balance
(in this case as it is the first year that B.
Swift has been in business) the capital
introduced, plus any profit made in the period,
less any amounts of money the owner/s have taken
out of the business.

61
EXAMPLE

From the following trial balance of B. Webb,
extracted after one years trading, prepare a
trading, profit and loss account for the year
ended 31 December 2006, and a balance sheet as of
that date.
The closing stock of B. Webb, at the 31 December
2006, is valued at 2,548.

62
B. WebbTrial Balance as at 31 December 2006