Significance of Agreement of Trial Balance

Significance of Agreement of Trial Balance

To prepare financial statements at the end of an accounting year, it is important that the trial balance should tally because it implies that both the debit and credit entries for each transaction have been posted correctly.

The significance of the agreement of trial balance is the arithmetical accuracy of posting the journal entries in the ledger accounts. It in no case provides a guarantee that the original entry is correct. Even when the trial balance tallies, there can be certain errors which affect both the debit and credit side equally, which eventually nullifies any difference.

Such errors can be in relation to –

• Wrong totalling of the debit and credit balances in the trial balance.
• Wrong totalling of subsidiary books.
• Error while posting the total amount of subsidiary books.
• Error in showing account balances in the wrong column of the trial balance, or in the wrong amount.
• Omission of an account balance while preparing the trial balance.
• Error committed while calculating a ledger account balance.
• Error in posting a journal entry to the ledger, i.e., posting made either with the wrong amount or on the wrong side of the account or in the wrong account.
• Error in recording a reverse entry in the journal, i.e., account to be debited is credited and amount to be credited is debited, or an entry with wrong amount.
• Recording a transaction in a subsidiary book with wrong name or amount.

Classification of Errors

The errors that can occur while preparing the trial balance can be classified into the following four categories:

• Errors of Commission
• Errors of Omission
• Errors of Principle
• Compensating Errors

1. Errors of Commission

Errors that are caused due to wrong posting of transactions, wrong totalling or wrong balancing of the accounts, wrong casting of the subsidiary books, or wrong recording of amount in the books of original entry, etc. are known as errors of commission. These are generally of clerical nature and they do affect the trial balance.

For example: A Ltd. paid Rs. 50,000 to B Ltd. (a supplier of goods). This transaction was correctly recorded in the cashbook. However, while posting the debit side of the entry, B’s account was debited with Rs. 5,000 only instead of Rs. 50,000. This constitutes an error of commission.

2. Errors of Omission

As the name suggests, the errors of omission are committed when an entry is either completely or partially omitted from the books of accounts while recording the transaction in the journal book or while posting to the ledger.

For example – credit sales made to A for Rs. 20,000 have not been entered in the sales book. This is a case of complete omission as both debit and credit sides have been neglected.

However, if such sale to A was duly recorded in the sales book but not posted to A’s account then it would have been a case of complete omission.

3. Errors of Principle

Principle here refers to the accounting principles that are followed while recording the entries. These principles are the generally accepted accounting principles as laid down by ICAI. Any errors resulting out of violation of these principles are known as errors of principle.

For eg – classifying an item of expenditure as capital expenditure instead of it being revenue in nature is an example of error of principle. This eventually has an effect on the financial statements as a whole.

Another example of error of principle is recording of credit purchase of furniture in the purchases book rather than in the journal proper.

These errors do not affect the trial balance as the amount of such errors is reflected in the trial balance although under the wrong heads.

4. Compensating Errors

Compensating Errors are the errors whose net effect on both the debit and credit side of the accounts is zero. Therefore, the trial balance in totality is not affected by these errors as these two or more errors are committed in a way that the total error amount becomes nil.

For example, if debit side of trial balance is reporting Rs. 10,000 in excess because purchases book has been overcast by Rs. 10,000 and credit side of trial balance is reporting Rs. 10,000 in short because sales book has been undercast by Rs. 10,000, then it is a case of errors compensating each other’s effect.

Thus, the significance of agreement of trial balance is not that it is an absolute proof of accuracy of accounts as it can still possess errors which do not affect the trial balance and can be discovered upon further scrutiny of account books.

Chapter 6 -Trial Balance and Rectification of Errors

1. Meaning of Trial Balance
2. Objectives of Preparing the Trial Balance
3. Preparation of Trial Balance – Trial Balance Questions
4. Significance of Agreement of Trial Balance
5. Searching of Errors
6. Rectification of Errors