Prepare a trial balance and explain its use.
To help prove that the accounting equation is in balance, a trial balance is normally prepared instead of the T-account listing shown in the previous section. A trial balance is an internal document that lists all the account balances at a point in time. The total debits must equal total credits on the trial balance. The form and content of a trial balance is illustrated below, using the account numbers, account names, and account balances of Big Dog Carworks Corp. at January 31, 2015. Assume that the account numbers are those assigned by the business.
Big Dog Carworks Corp.
At January 31, 2015
|670||Truck operation expense||700|
Double-entry accounting requires that debits equal credits. The trial balance establishes that this equality exists for Big Dog but it does not ensure that each item has been recorded in the proper account. Neither does the trial balance ensure that all items that should have been entered have been entered. In addition, a transaction may be recorded twice. Any or all of these errors could occur and the trial balance would still balance. Nevertheless, a trial balance provides a useful mathematical check before preparing financial statements.
Preparation of Financial Statements
Financial statements for the one-month period ended January 31, 2015 can now be prepared from the trial balance figures. First, an income statement is prepared.
The asset and liability accounts from the trial balance and the ending balances for share capital and retained earnings on the statement of changes in equity are used to prepare the balance sheet.
NOTE: Pay attention to the links between financial statements.
The income statement is linked to the statement of changes in equity: Revenues and expenses are reported on the income statement to show the details of net income. Because net income causes equity to change, it is then reported on the statement of changes in equity.
The statement of changes in equity is linked to the balance sheet: The statement of changes in equity shows the details of how equity changed during the accounting period. The balances for share capital and retained earnings that appear on the statement of changes in equity are transferred to the equity section of the balance sheet.
The balance sheet SUMMARIZES equity by showing only account balances for share capital and retained earnings. To obtain the details regarding these equity accounts, we must look at the income statement and the statement of changes in equity.