session 5

LMT SCHOOL OF MANAGEMENT, THAPAR UNIVERSITYMasters of Business Administration

Course: Financial Reporting and AnalysisFaculty: Dr. Sonia Garg (Email: [email protected])

Session 5: Process of Preparation of Financial Statements: Trial Balance

Duration: 60 minsSlides: 11

21/04/2023 Process of Preparation of Financial Statements: Trial Balance

2

Rules of Debit and CreditIn terms of the accounting equation

For Expenses and Income

AssetsDebit

to Increase

Credit to

Decrease

LiabilitiesDebit

to Decrease

Credit to

Increase

Owner’s EquityDebit

to Decrease

Credit to

Increase

ExpensesDebit

to IncreaseCredit

to Decrease

IncomeDebit

to DecreaseCredit

to Increase


3

Errors in trial balance

When debit balance = credit balance

• Error of principle: posting a journal entry to a wrong account will not affect the trial balance, e.g. for office rent if office equipment is debited instead of rent expense

• Error of omission and repetition: trial balance will not reveal a complete omission or repetition of a transaction

• Compensatory errors: recording of same erroneous amount for both debit and credit will not show up in the trial balance


4

Errors in trial balance

When debit balance is not equal to credit balance• Recording different amount for debit and credit in the

journal• Posting a debit as credit or vice versa• Computing an account balance incorrectly• Copying the amount of an account balance to the trial

balance incorrectly• Copying the debit balance in an account as credit balance or

vice versa, to the trial balance• Omitting an account balance from the trial balance• Totaling the trial balance incorrectly


5

Locating errorsUnfortunately there is no sure-shot method of locating differences, you can try the following short cuts

• If the amount of trial balance difference is divisible by 9 it indicates transposition of digits, e.g. 4921 written as 4291

• If the amount of trial balance difference is divisible by 2, look for an amount equal to the quotient in the trial balance. It indicates taking a debit as credit or vice versa

Best is to “ Do it right the first time”


6

Correcting Errors• An accountant must correct an error when he locates it• If error is discovered before making journal entries, it can be

corrected then and there• But if error is discovered after making journal entry, a correcting

entry needs to be made

For example: if rent expense account is debited instead of electricity expense account

Type of entry Account Heads Debit Credit

Incorrect Entry Dr…….Rent ExpenseCr…….Cash

43004300

Correct Entry Dr…….Electricity ExpenseCr…….Cash

43004300

Correcting Entry Dr…….Electricity Expense Cr……..Rent Expense

43004300


7

Correcting errors when trial balance does not balance

• The difference in trial balance is initially placed in a suspense account

• Then accounting records are scrutinized• Correcting entries are made by debiting or

crediting the Suspense account


8

Problems

Effect of Errors(a) A debit of Rs. 800 to Salaries Expense was overlooked and not

posted(b) Payment of Rs. 1400 for rent was recorded as a debit to Rent

Expense of Rs. 1400 and a credit to Cash of Rs. 140(c) Payment of annual insurance premium of Rs. 180 for the

company’s equipment was recorded as a debit to Equipment of Rs. 180 and a credit to Cash of Rs. 180

(d) A purchase of supplies of Rs. 2900 on credit was not recorded in the journal at all

(e) Payment of telephone bill of Rs. 430 was recorded in the amount of Rs. 430 as a debit to Cash and as a credit to Telephone Expense


9

Solution

Effect of Errors(a) The trial balance will not balance. Salaries Expense is

understated by Rs. 800(b) The trial balance will not balance. Cash is overstated by Rs.

1260(c) The trial balance will balance. Insurance Expense is

understated and Equipment is overstated(d) The trial balance will balance. Both Supplies and Creditors

(or Account Payable) are understated by Rs. 2900(e) The trial balance will balance. Cash is overstated and

Telephone Expense is understated by Rs. 860


10

Error Analysis and Correcting Entries

a) A cash receipt of Rs. 1900 for services yet to be provided was debited to cash and credited to Revenue from Services

b) A purchase of supplies of Rs. 4400 on credit was recorded as a debit to Supplies of Rs. 4400 and a credit to Cash of Rs. 4400

c) An interest payment of Rs. 1000 was debited to Bank Loan Payable and credited to Cash

d) Cash payment of Rs. 3600 to suppliers was recorded as a debit to Creditors of Rs. 6300 and credit to Cash of Rs. 3600


11

Solution

a) Effect: The trial balance will balance. Revenue from Services is overstated and Unearned Revenue is understated by Rs. 1900

b) Effect: The trial balance will balance. Creditors is overstated and Cash is understated by Rs. 4400

c) Effect: The trial balance will balance. Bank loan Payable is overstated and Interest Expense is understated by Rs. 1000

d) Effect: The trial balance will not balance. Creditors is understated by Rs. 2700

Correcting Entry Dr….Revenue from ServicesCr…. Unearned Revenue

19001900

Correcting Entry Dr…..Interest ExpenseCr……Bank Loan Payable

10001000

Correcting Entry Dr…..CashCr……Creditors

44004400

Correcting Entry Suspense AccountCreditors

27002700

session 5

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