Correcting Accounting Errors

From the previous studies, we learnt there were six steps to preparing final accounts, and in step five, we need to perform year-end adjustments or to correct any accounting errors. Particularly in manual accounting systems, accountants may frequently make mistakes.

9.1 Accounting Errors

This topic reminds me of when I was working as an accountant in a business. At that time, I was in charge of preparing the business’s final accounts. However, the statement of financial position did not balance, and I’d spent more than 36 hours trying to find out what had gone wrong. Finally, I noticed that one of my colleagues in the finance team had made errors regarding three business transactions. The total amount involved was only $900, a relatively small amount; we were still using the manual accounting system at that time and, hence, I did come to understand that while it was not time consuming for accountants to prepare Financial Statements, it was very time consuming for the accountant to pick up on and trace the origins of any errors, especially when the errors were small.

To get to the bottom of any accounting error, it is worth looking at the trial balance. If the balances in the trial balance do not agree, accounting errors must have taken place. But if the balances in the trial balance do agree, accounting errors may also exist as well.

9.2 Trial Balance Balances

Now, let’s look at the situations where accounting errors took place and the trial balance still balanced. Let’s look at the following simplified trial balance to detect those accounting errors.

Elements	Dr	Cr
Cash	$100
Sales Revenue		$100
Purchases	$50
Trade Payables		$50
	$150	$150

9.2.1 Error of Principle

The first accounting error is the error of principle. This means either the debit or credit side goes into the wrong Financial Statements but the side itself is correct. Let’s look at the following example:

A business made a $100 cash sale to a customer. The business should show:

Dr Cash $100

Cr Sales revenue $100

But the business has made the following wrong entry:

Dr Purchases $100

Cr Sales revenue $100

Please note that the debit side of the transaction should go into the statement of financial position because this is cash, but instead, it goes into the statement of profit or loss. However, the side of the transaction shown is debit, which is correct.

The trial balance still balances in this case:

Elements	Dr	Cr
Cash	0
Sales Revenue		$100
Purchases	$50+$100=$150
Trade Payables		$50
	$150	$150

9.2.2 Reversal Error

The second accounting error is called the reversal error. This means the debit and credit sides of the transaction have been reversed or swapped, and the trial balance still balances. Let’s look at the below example:

A business has made a $100 cash sale. The business should show:

Dr Cash $100

Cr Sales revenue $100

However, the business has made the following wrong entry:

Dr Sales revenue $100

Cr Cash $100

The debit and credit sides of the entry are reversed, but the trial balance still balances:

Elements	Dr	Cr
Cash		$100
Sales Revenue	$100
Purchases	$50
Trade Payables		$50
	$150	$150

9.2.3 Omission of the Entire Transaction

This is when both the debit and credit sides of the transaction are missing, i.e., the whole transaction is missing, and the trial balance still balances.

Example: the business has made $100 cash sale to the customer. The business should show:

Dr Cash $100

Cr Sales revenue $100

However, the entire transaction is missing. Let’s see the effect on the trial balance below:

Elements	Dr	Cr
Cash	0
Sales Revenue		0
Purchases	$50
Trade Payables		$50
	$50	$50

The total balances either in the debit or credit side should have been $150 but is shown as $50 in this case. The trial balance still balances, but the accounting error has occurred.

9.2.4 Commission Error

This is very similar to the principle error. However, the commission error takes place where either the debit or credit side goes into the correct Financial Statement but in the wrong section. Let’s look at the following example:

A business has purchased the goods on credit worth $50. The business should show:

Dr Purchases $50

Cr Trade payables $50

However, the business has made the following wrong entry:

Dr Purchases $50

Cr Capital $50

The credit side should be trade payables instead of capital account, but these are elements in the statement of financial position, i.e., they are the correct Financial Statements but in the wrong section.

Let’s look at the effect on the trial balance below:

Elements	Dr	Cr
Cash	$100
Sales Revenue		$100
Purchases	$50
Trade Payables		0
Capital		$50
	$150	$150

9.2.5 Compensating Error

This is where accounting errors occur in several journals and when these wrong balances are added up, the trial balance balances. Let’s look at the following example:

There are two business transactions. The first one is where the business has made a $100 cash sale to the customer. The second transaction is where the business purchased $50 worth of goods on credit. The business should make the following accounting entries:

First entry:

Dr Cash $100

Cr Sales revenue $100

Second entry:

Dr Purchases $50

Cr Trade payables $50

However, the business has made the following wrong entries:

First entry:

Dr Cash $50

Cr Sales revenue $100

Second entry:

Dr Purchases $100

Cr Trade payables $50

Let’s look at the effects on the trial balance below:

Elements	Dr	Cr
Cash	$50
Sales Revenue		$100
Purchases	$100
Trade Payables		$50
	$150	$150

The above trial balance still balances because those accounting errors compensate for each other.

9.2.6 Error of Original Entry

This is when the figures in the original entry are wrong. Let’s look at an example:

A business has made $100 cash sale to the customer. The business should show:

Dr Cash $100

Cr Sales revenue $100

However, the accountant has input has $5 instead of $100 as follows:

Dr Cash $5

Cr Sales revenue $5

Let’s look at the effect on the trial balance below

Elements	Dr	Cr
Cash	$5
Sales Revenue		$5
Purchases	$50
Trade Payables		$50
	$55	$55

The above trial balance still balances but both sides of the double entry are incorrect.

9.2.7 Duplication of Entries

This means that the journal entry has been duplicated, i.e., the same transaction has been posted twice. Let’s look at an example:

A business has made $100 cash sale to the customer. The business should show:

Dr Cash $100

Cr Sales revenue $100

However, the business has made the above entry again:

Dr Cash $100 x 2 = $200

Cr Sales revenue $100 x 2 = $200

Let’s look at the effect on the trial balance below:

Elements	Dr	Cr
Cash		$100x2=$200
Sales Revenue	$100x2=$200
Purchases	$50
Trade Payables		$50
	$250	$250

9.3 Trial Balance Does Not Balance

If the trial balance does not balance, accounting errors have been made.

9.3.1 Casting Error

This means that either the total debit or credit side has been calculated wrongly. For instance, the total debit side should have been calculated as $150 but shows as $80 here by mistake, making the trial balance imbalanced:

Elements	Dr	Cr
Cash	$100
Sales Revenue		$100
Purchases	$50
Trade Payables		$50
	Should show: $150	$150
	But shows: $80

This mistake is not common since nowadays, most businesses use computerised accounting software to detect such errors.

9.3.2 One-sided Posting Error

This is where one side of the entry has been made on the opposite side. Let’s look at the example again.

A business has made a $50 credit purchase. The business should show:

Dr Purchases $50

Cr Trade payables $50

However, the business has made the following wrong entry:

Dr Purchases $50

Dr Trade payables $50

Let’s look at the effect on the trial balance:

Elements	Dr	Cr
Cash	$100
Sales Revenue		$100
Purchases	$50
Trade Payables	$50
	$200	$100

9.3.3 Omission of a Single Entry

This is where either the debit or credit side of the transaction is missing. For example, instead of:

Dr Purchases $50

Cr Trade payables $50

The business has only made the following entry:

Dr Purchases $50

This means that the credit side of the entry is missing, making the trial balance imbalanced:

Elements	Dr	Cr
Cash	$100
Sales Revenue		$100
Purchases	$50
Trade Payables		0
	$150	$100

9.3.4 Transposition Error

This means the two digits in a transaction value are recorded the wrong way around on either the debit or credit side of the transaction.

For example, a business has made a credit sale of $110 to the customer. The business should show:

Dr Cash $110

Cr Sales revenue $110

However, the business has made the following entry:

Dr Cash $101

Cr Sales revenue $110

Let’s look at the effect on the trial balance below:

Elements	Dr	Cr
Cash	$101
Sales Revenue		$110
Purchases	$50
Trade Payables		$50
	$151	$160

The business can often detect a transposition error by checking whether the difference between debits and credits can be divided exactly by 9. In this case, $110-$101=$9 and $9 divided into 9 would equal to 1. Hence this indicates the transposition error has taken place.

9.4 Steps to Correct Accounting Errors

Three-step approach to correct accounting errors:

Step 1: What should be the correct accounting entry?

Step 2: What was the wrong accounting entry?

Step 3: Correct it.

Let’s look at an example below:

The business owner Tony has withdrawn $1,000 cash for personal expenses. However, the accountant has made the following double entry:

Dr Trade payables $1,000

Cr Cash $1,000

This is an example of commission error and the trial balance still balances.

Let’s apply the three-step approach to correct the accounting error:

Step 1: What should be the correct accounting entry?

Dr Drawings $1,000

Cr Cash $1,000

Step 2: What was the wrong accounting entry?

Dr Trade payables $1,000

Cr Cash $1,000

Step 3: Correct it.

Dr Drawings $1,000

Cr Trade payables $1,000

The trade payables account has been wrongly debited and this is corrected by crediting it. Now, the trade payables balance is nil. We then debit or increase the drawings account by $1,000.

9.5 Suspense Account

As at the financial statements’ year end, the drafted Financial Statements should be ready. Hence, the accountant may have been rushed into making several accounting errors in the first place. If the trial balance does not balance, the Financial Statements cannot be prepared. The reason is that if the balances do not agree, the accounting equation is not functioning properly, i.e., the assets do not equal the liabilities plus equity.

Accountants could use a ‘suspense account’ to temporarily force the trial balance balancing:

Elements	Dr	Cr
Cash	$101
Sales Revenue		$110
Purchases	$50
Trade Payables		$50
Suspense Account	$9
	$160	$160

From the above trial balance, the transposition error has taken place, and the debit side of the trial balance does not agree with the credit side. The accountant, therefore, creates a temporary suspense account to force the trial balance balances. And the ‘temporary’ Financial Statements look like this:

Statement of profit or loss:

Sales Revenue	$110
Purchases	$(50)
Profits	$60

Statement of financial position:

Assets:
Cash	$101
Suspense Account	$9
Total assets=	$110
Equity:
Profits from the statement of profit or loss	$60
Liability: Trade payables	$50
Total equity and liabilities =	$110

The suspense account needs to be corrected because it was temporarily created. To do so, we still apply the above three-step approach.

Step 1: What should be the correct accounting entry?

Dr Cash $110

Cr Sales revenue $110

Step 2: What was the wrong accounting entry?

Dr Cash $101

Dr Suspense account $9

Cr Sales revenue $110

Step 3: Correct it.

Dr Cash $9

Cr Suspense account $9

As you can see, the suspense account of $9 first created by the accountant is subsequently removed by crediting it. The cash account is then increased or debited by $9.

9.6 Quick Summary of This Chapter

Errors occurred where the trial balance balanced:

Error of principle
Reversal error
Omission of the entire transaction
Commission error
Compensating error
Error of original entry
Duplication of entries

Errors occurred where the trial balance did not balance and a suspense account was needed:

Casting error
One-sided posting error
Omission of a single entry
Transposition error

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Categories: : Financial Accounting (FA)