FA1 RECORDING FINANCIAL TRANSACTIONS

1.1 COMPUTERISED ACCOUNTING SYSTEMS

A trial balance is a list of all general ledger account balances at a specific date, classified as either debit balances or credit balances. The total of debit balances should equal the total of credit balances.

In a computerised accounting system, a trial balance can be produced automatically 'on demand. It should contain an equal value of debits and credits. However, this is not a guarantee that there are no errors or omissions in the trial balance as, for example, a transaction could be posted to the wrong ledger account. Equally, a computerised system is unlikely to allow a transaction to be partially recorded by posting only one half of the double-entry required.

Computerised accounting systems are designed to prevent the following errors which may occur in a manual accounting system:

• processing a single-sided accounting entry
• processing an unequal value of debits and credits when recording a transaction
• processing transactions which affect the payables or receivables general ledger accounts but not updating the individual payables' and receivables' ledger accounts
• processing the payables or receivables general ledger accounts and updating the individual payables' and receivables' ledger accounts incorrectly or incompletely.

Note, however, that a computerised system will permit posting of a transaction if one part of the double-entry is posted to the suspense account. This may occur, for example, if the person processing the transaction is unsure of the accounting entries required to record the transaction; one part of the transaction can be recorded in the suspense account pending further review or investigation. When the query resolved. the suspense account can be cleared by making a correcting journal adjustment. Suspense accounts are considered in more detail in this chapter.

Therefore, much of the content of this chapter relates to a manual accounting system, although these processes would be performed automatically by a computerised accounting system. It is important that you understand the underlying principles of what a trial balance is and how it is produced.

In a manual accounting system, accounts are 'ruled off or 'balanced off from time to time, perhaps at each month end, and the balance on each account is carried forward as an opening balance at the start of the next period.

• A debit balance on an account is shown as an opening balance brought down on the debit side of the account
• Similarly, if there is a credit balance on an account, the opening balance brought down at the start of a period should be on the credit side of the account

When preparing a trial balance, remember that account balances in the general ledger are

Within the general ledger, all transactions are recorded using the principles of double-entry bookkeeping with a debit entry in one account and a credit entry in another account, and the total value of debit entries and credit entries must always be the same. If they are not, something has gone wrong.

A trial balance checks whether the ledger accounts are correct, insofar as the total debit balances and total credit balances are equal.

The format of a trial balance is a list of accounts with a column for debit balances and a column for credit balances.

1.2 REASONS FOR PRODUCING A TRIAL BALANCE

There are three principal reasons for producing a trial balance.

At the end of the financial year, a trial balance is used as a starting point for preparation of the annual financial statements comprising a statement of comprehensive income and a statement of financial position. This is something you will encounter in your subsequent studies.

A trial balance shows the current balances on all the asset, liability, capital, income and expense accounts. This can provide useful information to management.

In a manual accounting system, preparing a trial balance is a procedure for identifying certain types of errors in the accounting records.

If the total of debit balances and the total of credit balances are not equal, there must have been one or more errors or omission when entering transactions in the ledger accounts. When the existence of an error has been identified, the next step is to carry out an investigation, and try to find where the double entry mistake or mistakes have happened. When the error has been found, it should be corrected.

Emors recording transactions as double-entry items in the ledgers are much more likely to occur in a manual accounting system than in a computerised accounting system. This is because in a computerised system, most transactions are recorded as double-entry items automatically, without the risk of human error.

Each business will have its own procedures for preparing a trial balance, and some will produce a trial balance more frequently than others. A business with a manual accounting system, however, should produce a trial balance frequently, perhaps monthly or weekly, so that if any errors have been made, their existence will be identified sooner rather than later, and tracking down the cause of the error or errors should be a quicker process.

1.3 PRODUCING AN INITIAL TRIAL BALANCE

An initial trial balance is a trial balance produced by listing all the ledger accounts in the general ledger with their debit or credit balances. It is referred to as an 'initial" trial balance because:

• if the total debits and total credits are not equal, the initial trial balance will have to be corrected
• a trial balance is used to prepare a statement of comprehensive income and a statement of financial position and in this process, a final trial balance will be prepared as the final stage towards producing the annual financial statements.

There are two stages in preparing an initial trial balance.

Example

If you think you understand the procedure for preparing an initial trial balance, you may like to attempt preparing your own solution to this example before you review the answer and explanation provided.

The general ledger accounts of Avalon as at 31 December 20X4 are noted below. Balance the accounts, bring down the balances and show all the balances in a trial balance.

The total debit balances and the total credit balances are equal at $2,350. It therefore appears that double-entry bookkeeping has been used consistently to record transactions in the accounting system.

The initial trial balance may be regarded as the starting point in the process to prepare the annual financial statements. Normally, there will be year-end adjustments to account for, including clearing any temporary suspense account balance along with rectifying any known errors before the annual financial statements are prepared.

ACTIVITY 1

The following are the ledger accounts of Ali's business for the year ended 31 May 20X5.

For a suggested answer, see the 'Answers' section at the end of the book