Trial Balance, Rectification of Errors, and Adjusting & Closing Entries

---

Trial Balance

Meaning of a Trial Balance

A trial balance is a statement that shows the debit and credit balances of all ledger accounts to verify the arithmetical accuracy of accounting entries.

Features of a Trial Balance

• Prepared at the end of an accounting period
• Contains all ledger account balances
• Shows debit and credit columns with equal totals
• Helps in preparing financial statements

Purpose of a Trial Balance

• Check arithmetic accuracy of ledger accounts
• Locate accounting errors
• Prepare basis for financial statements
• Provide summary of ledger accounts

Types of Trial Balance

• Unadjusted Trial Balance: Prepared before adjustments
• Adjusted Trial Balance: Prepared after adjustments
• Post-Closing Trial Balance: Prepared after closing entries

Preparation of a Trial Balance

1. List all ledger account names
2. Record debit balances in debit column
3. Record credit balances in credit column
4. Total both columns
5. Verify that totals match

Disagreement of a Trial Balance

When debit and credit totals don't match, it indicates errors that need investigation and rectification.

Rectification of Errors

Classification of Errors

• Errors of Omission: Complete or partial omission of entries
• Errors of Commission: Wrong recording of amounts or accounts
• Errors of Principle: Incorrect application of accounting principles
• Compensating Errors: Errors that offset each other

Location of Errors

1. Check arithmetic accuracy
2. Verify posting from journal to ledger
3. Compare opening balances with previous trial balance
4. Check for omitted accounts

Rectification of Errors

Errors are rectified by passing journal entries to correct the mistake while maintaining the original entry for audit trail.

Suspense Account and Rectification

A suspense account is a temporary account used to balance the trial balance when errors cannot be immediately located.

Rectification of Errors when Books are Closed

After books are closed, errors affecting profit are adjusted through the Profit and Loss Adjustment Account.

Adjusting and Closing Entries

Adjusting Entries

Entries made at the end of an accounting period to record accrued and deferred items to comply with the matching principle.

Closing Entries

Entries made to transfer temporary account balances (revenues, expenses, dividends) to permanent accounts (retained earnings) at period end.

Multiple Choice Questions

1. What is the primary purpose of a trial balance?

   1. To prepare financial statements
   2. To check arithmetic accuracy of ledger accounts
   3. To record business transactions
   4. To calculate profit or loss

   Answer: b) To check arithmetic accuracy of ledger accounts

2. Which type of trial balance is prepared after adjustments?

   1. Unadjusted trial balance
   2. Adjusted trial balance
   3. Post-closing trial balance
   4. Pre-closing trial balance

   Answer: b) Adjusted trial balance

3. When debit and credit totals of a trial balance don't match, it indicates:

   1. Perfect accounting records
   2. Presence of errors
   3. High profitability
   4. Excellent financial health

   Answer: b) Presence of errors

4. Which of the following is NOT a classification of accounting errors?

   1. Errors of omission
   2. Errors of commission
   3. Errors of principle
   4. Errors of management

   Answer: d) Errors of management

5. A temporary account used to balance the trial balance when errors cannot be immediately located is called:

   1. Nominal account
   2. Real account
   3. Suspense account
   4. Personal account

   Answer: c) Suspense account

6. Which account is used to rectify errors affecting profit after books are closed?

   1. Suspense account
   2. Profit and Loss Adjustment Account
   3. Capital account
   4. Drawings account

   Answer: b) Profit and Loss Adjustment Account

7. Adjusting entries are made to comply with which accounting principle?

   1. Cost principle
   2. Matching principle
   3. Revenue recognition principle
   4. Full disclosure principle

   Answer: b) Matching principle

8. Closing entries transfer balances from which type of accounts to retained earnings?

   1. Permanent accounts
   2. Temporary accounts
   3. Real accounts
   4. Personal accounts

   Answer: b) Temporary accounts

9. Which of the following errors will NOT affect the trial balance agreement?

   1. Error of complete omission
   2. Error of partial omission
   3. Error of principle
   4. Compensating errors

   Answer: c) Error of principle

10. The first step in preparing a trial balance is:

    1. Total both columns
    2. List all ledger account names
    3. Record debit balances
    4. Verify totals match

    Answer: b) List all ledger account names

---

Trial Balance, Rectification of Errors, and Adjusting & Closing Entries

Trial Balance

Simple Example: Preparing a Trial Balance

Given the following ledger balances:

• Cash: $5,000 (Debit)
• Accounts Receivable: $3,000 (Debit)
• Equipment: $10,000 (Debit)
• Accounts Payable: $4,000 (Credit)
• Capital: $12,000 (Credit)
• Revenue: $2,000 (Credit)

Prepare a trial balance and verify if it balances.

Solution: Total Debits = $18,000; Total Credits = $18,000 → Trial Balance agrees.

Medium Example: Trial Balance Disagreement

A trial balance shows:

• Total Debits: $45,670
• Total Credits: $45,230

The difference of $440 was placed in a Suspense Account. Later, it was found that:

1. A credit sale of $200 to Mr. X was recorded as $2,000
2. The purchase book was undercast by $160

Show the rectification entries and the final trial balance.

Solution:
1. Mr. X A/c Dr. $1,800; Suspense A/c Cr. $1,800
2. Purchase A/c Dr. $160; Suspense A/c Cr. $160
After rectification, Suspense A/c balance = $440 + $1,800 - $160 = $2,080 (Credit)

Hard Example: Comprehensive Trial Balance Preparation

From the following transactions for ABC Ltd. for March 2023:

1. Started business with cash $50,000
2. Purchased goods for $20,000 (10% on cash, balance on credit)
3. Sold goods for $30,000 (20% on cash, balance on credit)
4. Paid salaries $5,000
5. Received $10,000 from debtors
6. Paid $8,000 to creditors
7. Purchased equipment for $15,000 (paid $5,000 cash, balance payable)

Prepare ledger accounts and then the trial balance.

Solution:
Total Debits = Cash ($50,000 - $2,000 - $20,000 - $5,000 + $6,000 - $10,000 - $5,000) + Purchases $20,000 + Debtors $24,000 - $10,000 + Salaries $5,000 + Equipment $15,000 = $73,000
Total Credits = Capital $50,000 + Creditors $18,000 - $8,000 + $10,000 + Sales $30,000 = $100,000
Note: This shows an imbalance indicating possible missing entries or errors.

Rectification of Errors

Simple Example: Error of Commission

A payment of $500 to supplier Mr. A was wrongly recorded as payment to Mr. B. Show the rectification entry.

Solution:
Mr. B's A/c Dr. $500
Mr. A's A/c Cr. $500

Medium Example: Error of Principle

Purchase of furniture worth $2,000 was recorded in the purchases account. Show the rectification entry if discovered before closing books.

Solution:
Furniture A/c Dr. $2,000
Purchases A/c Cr. $2,000

Hard Example: Comprehensive Error Rectification

While preparing final accounts, the following errors were detected:

1. Sales book undercast by $1,000
2. Purchase return of $500 was recorded in sales return book
3. Depreciation of $2,000 was not recorded
4. Credit sale of $800 to Ramesh was recorded as $8,000

Show rectification entries assuming books are not yet closed.

Solution:
1. Sales A/c Dr. $1,000; Suspense A/c Cr. $1,000
2. Sales Return A/c Dr. $500; Purchase Return A/c Cr. $500
3. Depreciation A/c Dr. $2,000; Asset A/c Cr. $2,000
4. Ramesh A/c Dr. $7,200; Sales A/c Cr. $7,200

Adjusting and Closing Entries

Simple Example: Prepaid Expense

Insurance premium of $1,200 was paid for one year on July 1. Adjust the prepaid insurance for December 31 year-end.

Solution:
Insurance Expense A/c Dr. $600 (6 months)
Prepaid Insurance A/c Cr. $600

Medium Example: Accrued Income and Closing Entries

At year-end:

1. Rent receivable $500 is accrued
2. Total revenues $80,000 and expenses $65,000 need to be closed

Show adjusting and closing entries.

Solution:
Adjusting: Accrued Rent A/c Dr. $500; Rent Revenue A/c Cr. $500
Closing:
Revenue A/c Dr. $80,500; Income Summary Cr. $80,500
Income Summary Dr. $65,000; All Expense A/cs Cr. $65,000
Income Summary Dr. $15,500; Retained Earnings Cr. $15,500

Hard Example: Comprehensive Adjustments

Prepare adjusting entries for December 31 given:

1. Unearned revenue balance is $3,000, $1,500 is earned
2. Depreciation on equipment is $4,000
3. Salaries payable are $2,500
4. Office supplies used during year: $800 from $1,200 balance
5. Interest receivable: $300

Solution:
1. Unearned Revenue Dr. $1,500; Revenue Cr. $1,500
2. Depreciation Expense Dr. $4,000; Accum. Depreciation Cr. $4,000
3. Salaries Expense Dr. $2,500; Salaries Payable Cr. $2,500
4. Supplies Expense Dr. $800; Office Supplies Cr. $800
5. Interest Receivable Dr. $300; Interest Revenue Cr. $300