The Trial Balance and the Accounting Equation
Purpose of the trial balance
A trial balance lists every ledger balance at a chosen date in a debit column and a credit column. If the double entry has been arithmetically correct, the two columns agree. It is a check on arithmetic, not proof that the records are right, and it is the starting point for the statement of financial position and the statement of profit or loss.
Errors
Some errors throw the trial balance out: a one-sided entry, a casting (addition) error, a balance entered in the wrong column, or different amounts entered on the two sides. Others leave it in agreement: omission (a transaction not recorded at all), commission (right side, wrong account of the same class), principle (wrong class of account, e.g. motor expense instead of motor vehicle), original entry (wrong amount in both accounts), reversal of entries, and compensating errors that cancel out.
The accounting equation
Assets = Capital + Liabilities, and expanded: Assets = Capital + Profit − Drawings + Liabilities, where profit is income less expenses.
Traps
- Drawings reduce capital; they are not an expense.
- A bank loan is a liability, not capital.
- Buying an asset on credit increases assets and liabilities by the same amount and leaves capital unchanged.
Worked example
Assets of £80,000 and liabilities of £30,000 give capital of £50,000. The owner then introduces £10,000 of cash: assets become £90,000 and capital £60,000, so the equation still balances.