Correction of accounting errors
Accountants prepare a trial balance to check the correctness of the accounts. If the total of the debit balances does not match the total of the credit balances, this is a clear indication that certain errors have been made in recording the transactions in the books of original entry or subsidiary books. It is our primary duty to locate these errors and correct them, only then should we proceed to prepare final reports. We also know that all types of errors are not revealed by the trial balance because some of the errors do not affect the trial balance total. So they cannot be located using the trial balance. The accountant must invest his energy in locating both types of errors and correcting them before preparing a business activity, income statement, and balance sheet. Because if they are prepared before the correction, they will not give us the correct result and the profit and loss announced by them will not be the actual profit or loss.
All errors in the accounting procedure can be classified as follows:
1. Fundamental errors
When a transaction is recorded against the fundamental principles of accounting, it is a fundamental error. For example, if revenue expenditure is treated as capital expenditure or vice versa.
2. Clerical errors
These errors can again be subdivided as follows:
(i) Errors of Omission
When a transaction is not recorded in whole or in part in the books of account, it is an error of omission. It may be in respect of failure to enter a transaction in the books of original entry or in respect of failure to post a transaction from the books of original entry to the relevant account in the ledger.
(ii) Errors of Commission
When an entry is incorrectly recorded in whole or in part – incorrect accounting, calculation, casting or balancing. Some commission errors affect the trial balance, while others do not. Errors affecting the trial balance can be detected by preparing the trial balance.
(iii) Compensation for Errors
Sometimes one error is offset by another error in such a way that it is not revealed by the trial balance. Such errors are called compensating errors.
From the point of view of error correction, they can be divided into two groups:
(a) Errors affecting only one account and
(b) Errors Affecting Two or More Accounts.
Errors affecting one account
Errors that affect can be:
(a) Casting Errors;
(b) an accounting error;
(c) transfer;
d) balancing; and
e) trial balance omission.
Such errors must first of all be located and corrected. They are adjusted either by means of a journal entry or by giving an explanatory note in the relevant account.
Correction
Stages of correction of accounting errors
All types of errors in accounts can be corrected in two stages:
(i) before the preparation of the final accounts; and
(ii) after the final accounts are drawn up.
Fixed bugs within the reporting period
The correct method of correcting an error is to pass a journal entry in such a way as to correct the error that was committed and also to give effect to the entry that should have been passed. But while the errors are corrected before the final accounts are prepared, in certain cases the correction cannot be made with the aid of the journal as the errors were. Normally the adjustment procedure, if made before the final accounts are prepared, is as follows:
(a) Correction of errors affecting one side of an account Such errors do not allow the trial balance to be reconciled because they affect only one side of an account, so they cannot be corrected by means of a journal entry if required adjustment before preparation of final accounts. So the required amount is placed on the debit or credit side of the respective account as the case may be. For example:
(i) Sales book under votes of Rs. 500 in the month of January. The error is only in the sales account to correct the sales account we have to write in the credit side of the sales account “By under casting of. sales book for the month of January Rs. 500″.I’Explanation: Since the sales ledger was less than Rs.500, it means that all the accounts other than the sales account are correct, only the credit balance of the sales account is less by 500 Rs.So Rs.500 is credited to Sales Account.
(ii) Allowed Marshall Discount Rs. 50, has not been posted to a discount account. This means that an amount of Rs. 50 which should have been debited in the discount account was not debited so the debit side of the discount account was reduced by the same amount. We have to debit Rs. 50 in the discount bill now which was missed earlier and the discount bill will be corrected.
(iil) Goods sold to X wrongly debited in the sales account. This error affects only the sales account because the amount that should have been posted on the credit side was wrongly placed on the debit side of the same account. To correct it, we need to put double the amount of the transaction on the credit side of the sales account, writing “By Sales of X, previously incorrectly debited”.
(iv) A sum of Rs. 500 paid to Y, not debited from his personal account. This error affecting only Y’s personal account and its debit side is less by Rs. 500 due to failure to post the amount paid. Now we will write on its debit side. “For encashment (missed posting) Rs.500.
Fix bugs affecting two parties on two or more accounts
Since these errors affect two or more accounts, the correction of such errors, if made before the final accounts are prepared, can often be accomplished by means of a journal entry. On correcting these errors, the amount is debited to one account/accounts while a similar amount is credited to another account/accounts.
Correcting errors in the next reporting period
As stated earlier that it is advisable to locate and correct errors before the final accounts for the year are prepared. But in some cases, when after a long search the accountant fails to find the errors and is in a hurry to prepare the final accounts of the business for filing return for sales tax or income tax purposes, he transfers the difference amount from trial balance to a newly opened “Suspense account’. In the next accounting period, as well as when errors are discovered, they are corrected in relation to the temporary account. When all errors are detected and corrected, the temporary account is automatically closed. Here we should not forget that only those errors that affect the trial balance amounts can be corrected using a temporary account. These errors, which do not affect the trial balance, cannot be corrected using a temporary account. For example, if it is found that the total debit of the trial balance was less by Rs. 500 for the reason that Wilson’s account was not debited with Rs. 500, the following adjusting entry should be passed.
Trial balance difference
The trial balance is only affected by errors that are corrected using the suspense account. Therefore, to calculate the difference in the provisional account, a table will be prepared. If the suspense account is debited in the adjusting entry, the amount will be placed on the debit side of the table. On the other hand, if the suspense account is credited, the amount will be placed on the credit side of the table. Eventually, the balance is calculated and reversed into the suspense account. If the credit side exceeds, the difference will be placed on the debit side of the suspense account. Effect of errors on final accounts
1. Errors affecting the statement of income and expenses
It is important to note the effect that en-or will have on the firm’s net profit. One point to remember here is that only those accounts which are transferred to the trading and profit and loss account during the preparation of the final accounts affect the net profit. This means that only errors in the nominal accounts and the goods account will affect the net profit. An error in these accounts will increase or decrease net profit.
How errors or their correction affect profit-following rules are useful to understand:
(i) If due to an error in a nominal account any debit is given, the profit will decrease or the losses will increase, and when it is corrected, the profits will increase and the losses will decrease. For example, machines are repaired for Rs. 10,000 but the amount debited to the machinery repair account – this error will reduce the profit. On an adjusting entry, the amount will be transferred to the machinery account from the machinery repair account and this will increase profits.
(il) If, due to an error, the amount is omitted from being recorded in the debit side of a nominal account – this leads to an increase in profits or a decrease in losses. Correcting this error will have the opposite effect, meaning that the profit will be reduced and the losses will be increased. For example, rent paid to the landlord, but the amount was debited to the landlord’s personal account – this will increase the profit, as the cost of rent is reduced. When the error is rectified, we will post the necessary amount to the rental account, which will increase rental costs and thus reduce profits.
(iil) Profits will increase or losses will decrease if a nominal account is incorrectly credited. By correcting this error, profits will decrease and losses will increase. For example, investments are sold and the amount is credited to the sales account. This error will increase profits (or decrease losses), when the same error is corrected, the amount will be transferred from the sales account to the investment account, therefore sales will be reduced, resulting in a decrease in profits (or an increase in losses ).
(iv) Profit will be reduced or losses will be increased if an account is omitted from posting on the credit side of a nominal or commodity account. When the same is corrected, it will increase the profit or decrease the losses. For example, the commission received is omitted to be posted to the commission credit account. This error will reduce profits (or increase losses) because the income is not credited to the profit and loss account. When the error is corrected, it will have an adverse effect on the profit and loss, as additional income will be credited to the profit and loss account, so that the profit will increase (or the losses will decrease). If due to any mistake a profit or loss is realized, it will have an effect on the capital account also because the profits are credited and the losses are debited in the capital account and so the capital will also increase or decrease. Since capital is shown on the liability side of the balance sheet, any error in the nominal account will also affect the balance sheet. So we can say that an error in the nominal account or goods account affects the income statement as well as the balance sheet.
2. Errors affecting only the balance
If an error is made in a real or personal account, it will affect the assets, liabilities, debtors or creditors of the firm and as a result will only have its effect on the balance sheet. as these items appear only in the balance sheet and the balance sheet is prepared after the income statement is prepared. So if there is an error in the cash account, bank account, asset or liability account, it will only affect the balance sheet.
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