How is the Best Way to Deal with a Trial Balance in Accounting?

I love this question! Lots of great stuff, if you look at it carefully….

“to deal with” meaning, “how do I handle it!”

You want to handle it with care. It’s the summary balances of all the accounts and it can tell you a lot. You are probably going to have to make some adjusting entries, and the trial balance will lead you to many of them.

“best way” meaning, “what should I do?”

Here we want to be methodical. First off, check to see if the thing balances, i.e. debits equal credits. Don’t be fooled by programs like QuickBooks, which force the difference into an imaginary account like “opening balance equity.” (BTW, that should always be zero). Even the best accounting programs can fall out of balance. Got to check that first. If it is out of balance, wow, there is so much potential work to do… can’t live with an out of balance trial balance!

Second, methodically go down the balance sheet. Start with cash. The amount in the trial balance is probably wrong. Did you do a bank reconciliation? Do you have the adjustments for things like outstanding checks, bank fees, interest, etc? If all you did was download the bank data into your accounting program and push a button, you’ve got work to do.

You’ll get the bank balance correct, then look at the investment accounts (savings accounts, etc) and adjust for interest earned, etc. Follow the balance sheet down to accounts receivable. Do you have an aging? Does it balance to the control figure on the trial balance ( yes, sometimes QuickBooks and similar programs are off… and you need to know why). Then, go down to inventory. Where did that figure come from? Has it been adjusted? Did you take inventory or estimate it using the retail method or gross profit method? Pause and consider that figure for a while. Then go to prepaids… do they look OK? What’s in the other current assets… loans to employees? Are these things properly valued?

Then we get to property, plant and equipment. You need to look at the depreciation schedule. Oops, forgot to record depreciation? Wait a minute, are all those assets still around? Should we adjust for things scrapped but not recorded on the books?

Finally, we have other assets. What’s there, and is it correct? Oftentimes other assets ends up a dumping ground for “get-around-to-its.” Now is the time to clean it out.

Done with the assets, now to the liabilities. Repeat the same methodology for each account. What is this figure? Where does it come from? How can it be “tied” or verified to some other data, like a statement from vendors, a loan statement, etc. Look out for accruals… things that haven’t been recorded.

Finally, we come to the equity. For most companies, things don’t change much in those accounts, but there are exceptions. Just take a careful look to see if everything looks OK.

Now on to the income accounts. Sales and sales offset accounts should tie to registers (subsidiary ledgers in the old paper days). Look to see if sales returns looks reasonable. Sometimes in modern systems, returns get netted against sales at the recording point, and that distorts the numbers. You want sales returns to be a separate figure so you can analyze it. The same goes for sales discounts, coupon discounts, etc. You may wish to look at your sales register and break out sales by line, location or other meaningful way. Lumping everything into one revenue account is, well, simple but stupid.

Next, look at cost of sales. This is where you really have to sharpen your mechanical pencil (joke) and pay attention. If you are in a service business, you should still have a “cost of sales” but it’s more like “project costs” or “cost of providing services.” Here some careful ratio analysis and comparison to trends makes a lot of sense. Do you have any way of measuring waste and loss? OK, so all of this analysis borders on cost accounting, but it’s part of what you should do when looking at a trial balance, skeptically.

Next, we get to the operating expenses. Here a horizontal analysis (comparing amounts over time) becomes very helpful. You want to focus on each account briefly, thinking about what’s in that account. Is there any way to verify it’s accuracy? A quick antidote may help. We had a trial balance which contained a lot of “contractor expenses” in G&A. I wondered why. Shouldn’t that be a part of cost of operations or project costs? Turned out the owner was running his home cleaning service and baby sitter through the company books under this account. A brief discussion of tax fraud cured that problem.

Don’t be afraid to dig into the detail and spot check accounts. What is in “internet services” or “advertising?” What got put in “bad debts?” If you spend a little time being an “armchair detective” you can uncover amazing information, unearth stupid bookkeeping errors, and ensure that the books are really correct. Some areas I love to look at include: depreciation, amortization, taxes, payroll, repairs, maintenance, miscellaneous and professional services.

Now you are at the end of the trial balance. You’ve got a lot of things that need to be tweaked to make the accounts accurate. Post those entries, then compare the results, in the form of a new trial balance ( the “adjusted” trial balance”) to the original one, to ensure that what you did worked out OK.

I always document the work that I did on each account, and I mark up the original trial balance with notes and references. In other words, I have a well documented trail as to where I went and what I did. On top is the adjusted trial balance. Next is the original trial balance, followed by all my worksheets, notes, etc. All done in paper. I then scan the whole mess and keep it by month. Anyone, anytime can see what I did, how I did it, and follow it.

Once you get into this routine, you can do it quickly and efficiently. Once you are done, you have completed about half the work you need to do for a monthly analysis package.

When the financials are run, you can now easily create a backup set of workpapers which support each number on the financial statements. You can also use your work to start on the analysis process, wherein you prepare the ratios necessary to interpret the financials, the vertical analysis ( each number as a percentage of a total) and horizontal analysis ( comparing figures over time). You also now have a good idea what’s in the numbers, so comparing to industry standards or norms will make more sense ( you can adjust as necessary to avoid distortions).

Wow! You have a great grasp of what went on in the business. You can now confidently present those financials, knowing where they came from, what they contain, and most importantly, what they mean. You are a great accountant!

For more information about bookkeeping, accounting, and financial analysis processes, check out CEAnow.org.

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