The Adjusted Trial Balance Is Prepared

The adjusted trial balance acts as a crucial checkpoint in the accounting cycle, ensuring the accuracy and reliability of financial statements. It's a listing of all general ledger accounts and their balances after adjusting entries have been made. This process is fundamental for businesses of all sizes, guaranteeing that financial reports reflect a true and fair view of the company's financial position and performance.

Understanding the Adjusted Trial Balance

The adjusted trial balance is not a financial statement itself, but rather a worksheet used to prepare the income statement, balance sheet, and statement of cash flows. Its primary purpose is to verify that the total debits equal the total credits after all adjusting entries have been posted. This ensures that the accounting equation (Assets = Liabilities + Equity) remains in balance.

Before diving into the "how," let's recap why this step is necessary. During the normal course of business, transactions are recorded in the general journal and then posted to the general ledger. This initial trial balance, prepared before any adjustments, often contains inaccuracies or omissions. These discrepancies arise because certain transactions or events aren't captured by the routine recording process. These include:

• Accruals: Revenues earned but not yet received in cash, and expenses incurred but not yet paid.
• Deferrals: Cash received for services not yet performed (unearned revenue) or cash paid for expenses that benefit future periods (prepaid expenses).
• Depreciation: The allocation of the cost of a tangible asset over its useful life.
• Estimates: Allowances for doubtful accounts and other estimations that require periodic adjustments.

Without these adjustments, financial statements would present an incomplete and misleading picture of the company's financial standing.

Preparing the Adjusted Trial Balance: A Step-by-Step Guide

Here’s a detailed breakdown of how to prepare an adjusted trial balance:

Step 1: Prepare the Unadjusted Trial Balance

• Gather all the general ledger accounts and their ending balances at the end of the accounting period. This is your starting point.
• List all the accounts in a worksheet format, typically in the following order: Assets, Liabilities, Equity, Revenues, and Expenses.
• Enter the debit or credit balance for each account in the appropriate column.
• Total the debit and credit columns. They should be equal. If they are not, there is an error in the initial recording or posting process that needs to be identified and corrected before proceeding. Common errors include:
  • Transposition errors: Switching digits (e.g., writing $123 as $132).
  • Omission errors: Failing to record a transaction altogether.
  • Posting errors: Incorrectly posting a debit or credit to the wrong account.
  • Addition errors: Mistakes in totaling the debit and credit columns.

Step 2: Identify and Analyze the Necessary Adjusting Entries

This is the core of the adjusted trial balance process. It requires a thorough understanding of accrual accounting principles. Here's a closer look at common types of adjusting entries:

• Accrued Revenues: These represent revenues earned but not yet recorded because the cash has not been received.

  • Example: A consulting firm provides services in December but doesn't bill the client until January. An adjusting entry is needed in December to recognize the revenue earned.
  • Journal Entry: Debit Accounts Receivable, Credit Service Revenue.

• Accrued Expenses: These are expenses incurred but not yet paid.

  • Example: Salaries earned by employees in December are paid in January. An adjusting entry is required in December to recognize the salary expense.
  • Journal Entry: Debit Salaries Expense, Credit Salaries Payable.

• Deferred Revenues (Unearned Revenues): This occurs when a company receives cash in advance for services or goods to be provided in the future.

  • Example: A magazine publisher receives payment for a one-year subscription. The revenue is earned gradually over the year as each issue is delivered.
  • Journal Entry (at the end of each period): Debit Unearned Revenue, Credit Subscription Revenue.

• Deferred Expenses (Prepaid Expenses): These are expenses paid in advance that benefit future periods.

  • Example: A company pays for a one-year insurance policy. The expense is recognized gradually over the year as the insurance coverage is used.
  • Journal Entry (at the end of each period): Debit Insurance Expense, Credit Prepaid Insurance.

• Depreciation: This is the systematic allocation of the cost of a tangible asset over its useful life.

  • Example: A company purchases a machine. Depreciation expense is recorded each period to reflect the decline in the asset's value.
  • Journal Entry: Debit Depreciation Expense, Credit Accumulated Depreciation.

• Bad Debts: This involves estimating the amount of accounts receivable that are unlikely to be collected.

  • Example: A company estimates that a certain percentage of its outstanding accounts receivable will be uncollectible.
  • Journal Entry: Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts.

Step 3: Prepare the Adjusting Entries

For each adjusting entry identified in Step 2, prepare the corresponding journal entry. This involves determining which accounts need to be debited and credited, and the amount of the adjustment. It's crucial to ensure that each adjusting entry maintains the debit-credit equality.

Step 4: Post the Adjusting Entries to the General Ledger

After preparing the adjusting entries, post them to the respective general ledger accounts. This involves updating the account balances to reflect the adjustments. Make sure that all adjusting entries are properly documented and traceable.

Step 5: Create the Adjusted Trial Balance Worksheet

This worksheet typically has the following columns:

• Account Name: Lists all the general ledger accounts.
• Unadjusted Trial Balance: Contains the debit and credit balances from the initial trial balance (Step 1).
• Adjustments: Contains the debit and credit amounts of the adjusting entries (Step 3 & 4).
• Adjusted Trial Balance: Contains the updated debit and credit balances after incorporating the adjustments. This is calculated by adding or subtracting the adjustments from the unadjusted balances.

Step 6: Calculate the Adjusted Balances

For each account, calculate the adjusted balance by combining the unadjusted balance with the adjustments.

• If the unadjusted balance is a debit and the adjustment is a debit, add them together.
• If the unadjusted balance is a debit and the adjustment is a credit, subtract the credit from the debit.
• If the unadjusted balance is a credit and the adjustment is a credit, add them together.
• If the unadjusted balance is a credit and the adjustment is a debit, subtract the debit from the credit.

Enter the adjusted balances in the appropriate debit or credit column of the adjusted trial balance worksheet.

Step 7: Total the Adjusted Debit and Credit Columns

Sum the debit and credit columns of the adjusted trial balance. The total debits should equal the total credits. If they do not, there is an error in the adjusting entries or the calculation of the adjusted balances. You need to re-examine your work to identify and correct the error before proceeding.

Step 8: Review and Verify the Adjusted Trial Balance

Thoroughly review the adjusted trial balance to ensure its accuracy and completeness. Verify that all adjusting entries have been properly recorded and posted, and that all account balances are correctly stated.

Example of Preparing an Adjusted Trial Balance

Let's consider a simplified example of a small business, "Sunshine Cleaning Services." At the end of December, Sunshine Cleaning Services prepares its unadjusted trial balance and identifies the following adjustments:

• Accrued Revenue: $500 for cleaning services performed but not yet billed.
• Prepaid Insurance: $200 of insurance coverage has expired.
• Depreciation: $300 of depreciation expense on cleaning equipment.
• Accrued Salaries: $400 of salaries owed to employees.

Here's how the adjusted trial balance would be prepared:

(1) Unadjusted Trial Balance (Partial)

Account Name	Debit	Credit
Cash	$5,000
Accounts Receivable	$2,000
Prepaid Insurance	$600
Cleaning Equipment	$10,000
Accumulated Depreciation		$1,000
Salaries Expense	$1,500
Insurance Expense	$0
Service Revenue		$8,000
Salaries Payable		$0

(2) Adjusting Entries

• Accrued Revenue:
  • Debit Accounts Receivable $500
  • Credit Service Revenue $500
• Prepaid Insurance:
  • Debit Insurance Expense $200
  • Credit Prepaid Insurance $200
• Depreciation:
  • Debit Depreciation Expense $300
  • Credit Accumulated Depreciation $300
• Accrued Salaries:
  • Debit Salaries Expense $400
  • Credit Salaries Payable $400

(3) Adjusted Trial Balance

Account Name	Unadjusted Debit	Unadjusted Credit	Adjustments Debit	Adjustments Credit	Adjusted Debit	Adjusted Credit
Cash	$5,000				$5,000
Accounts Receivable	$2,000		$500		$2,500
Prepaid Insurance	$600			$200	$400
Cleaning Equipment	$10,000				$10,000
Accumulated Depreciation		$1,000		$300		$1,300
Salaries Expense	$1,500		$400		$1,900
Insurance Expense	$0		$200		$200
Depreciation Expense	$0		$300		$300
Service Revenue		$8,000		$500		$8,500
Salaries Payable		$0		$400		$400
Totals	$19,100	$9,000	$1,400	$1,400	$20,300	$10,200

Important Note: In a real-world scenario, the adjusted trial balance would include all accounts from the general ledger, not just a selection as shown in this example for simplicity. The totals of the adjusted debit and credit columns must be equal to ensure the accounting equation is in balance. In this simplified example, we see that the total debits ($20,300) equals the total credits ($10,200) after the adjustments are made and incorporated into the adjusted trial balance.

Benefits of Preparing an Adjusted Trial Balance

• Accuracy of Financial Statements: Ensures that financial statements are based on accurate and up-to-date information, reflecting the true financial position and performance of the company.
• Compliance with GAAP: Helps companies comply with Generally Accepted Accounting Principles (GAAP), which require accrual accounting and the recognition of revenues and expenses in the period they are earned or incurred.
• Improved Decision-Making: Provides management with reliable financial data for making informed business decisions.
• Error Detection: Helps identify errors in the initial recording or posting of transactions, as well as omissions of necessary adjustments.
• Audit Readiness: Facilitates the audit process by providing auditors with a clear and organized record of the adjusting entries and their impact on the account balances.
• Internal Control: Strengthens internal control by providing a mechanism for verifying the accuracy and completeness of the accounting records.

Common Mistakes to Avoid

• Failing to Identify All Necessary Adjustments: Overlooking accruals, deferrals, or depreciation can lead to inaccurate financial statements.
• Incorrectly Calculating Adjustments: Errors in calculating the amount of the adjusting entries can distort the account balances.
• Posting Adjusting Entries to the Wrong Accounts: Posting adjustments to the wrong accounts can lead to significant errors in the financial statements.
• Forgetting to Update the General Ledger: Failing to post the adjusting entries to the general ledger will result in discrepancies between the adjusted trial balance and the underlying accounting records.
• Not Verifying Debit-Credit Equality: Failing to ensure that the total debits equal the total credits in the adjusted trial balance indicates an error that needs to be corrected.
• Using the Cash Basis of Accounting When Accrual is Required: Many businesses, particularly larger ones, must use accrual accounting, not simply record transactions when cash changes hands.

Technology and the Adjusted Trial Balance

Modern accounting software has significantly streamlined the process of preparing the adjusted trial balance. These systems automate many of the manual tasks involved, such as posting adjusting entries and calculating adjusted balances.

• Automation: Software can automatically generate adjusting entries based on predefined rules and schedules.
• Real-Time Updates: Account balances are updated in real-time as transactions are recorded and adjustments are made.
• Error Detection: Systems often have built-in error detection capabilities to identify inconsistencies or errors in the data.
• Reporting: Software can generate the adjusted trial balance and other financial reports with ease.
• Cloud-Based Solutions: Cloud-based accounting software allows for remote access and collaboration, making it easier for accountants and auditors to work together.

However, even with the use of technology, it's important to understand the underlying principles of the adjusted trial balance and to carefully review the results to ensure their accuracy. Software can reduce the risk of manual errors, but it cannot replace the need for professional judgment and expertise.

Frequently Asked Questions (FAQ)

• What is the difference between a trial balance and an adjusted trial balance?

  • A trial balance is a listing of all general ledger accounts and their balances before any adjusting entries are made. An adjusted trial balance is a listing of all general ledger accounts and their balances after adjusting entries have been made.

• When is the adjusted trial balance prepared?

  • The adjusted trial balance is prepared at the end of each accounting period, typically monthly, quarterly, or annually.

• Is the adjusted trial balance a financial statement?

  • No, the adjusted trial balance is not a financial statement. It is a worksheet used to prepare the financial statements.

• What happens if the debits and credits don't match on the adjusted trial balance?

  • If the debits and credits don't match, it indicates an error in the adjusting entries or the calculation of the adjusted balances. The error needs to be identified and corrected before proceeding.

• Can I prepare an adjusted trial balance using a spreadsheet?

  • Yes, you can prepare an adjusted trial balance using a spreadsheet program like Microsoft Excel or Google Sheets. However, accounting software is generally more efficient and less prone to errors.

• Why are adjusting entries necessary?

  • Adjusting entries are necessary to ensure that financial statements are prepared using the accrual basis of accounting, which requires revenues and expenses to be recognized in the period they are earned or incurred, regardless of when cash is received or paid.

Conclusion

The adjusted trial balance is a cornerstone of the accounting cycle. By systematically identifying and recording necessary adjustments, businesses can ensure that their financial statements present a true and fair view of their financial position and performance. While technology has made the process more efficient, a thorough understanding of the underlying principles and careful review of the results remain essential for maintaining the integrity of the accounting records. Mastering the preparation of an adjusted trial balance empowers businesses to make sound financial decisions, comply with accounting standards, and build trust with stakeholders.