Rectification Of Accounting Errors
Every businessman is interested in finding out the true
profit and correct financial position of his business at the close of the
trading period. The effort of the accountant is to prepare the final accounts in
such a fashion which exhibits true picture of the business. Accounts are
considered to be authentic proof of true financial position of a concern. But in
spite of best efforts there are certain transactions which are omitted to be
recorded or entered wrongly in the books. Such errors affect the final accounts.
An accountant should, therefore, try to locate such errors and rectify them
before the preparation of final accounts.
Accountants prepare trial balance to check the correctness of
accounts. If total of debit balances does not agree with the total of credit
balances, it is a clear-cut indication that certain errors have been committed
while recording the transactions in the books of original entry or subsidiary
books. It is our utmost duty to locate these errors and rectify them, only then
we should proceed for preparing final accounts. We also know that all types of
errors are not revealed by trial balance as some of the errors do not effect the
total of trial balance. So these cannot be located with the help of trial
balance. An accountant should invest his energy to locate both types of errors
and rectify them before preparing trading, profit and loss account and balance
sheet. Because if these are prepared before rectification these will not give us
the correct result and profit and loss disclosed by them, shall not be the
actual profit or loss.
All errors of accounting procedure can be classified as
follows:
1. Errors of Principle
When a transaction is recorded against the fundamental
principles of accounting, it is an error of principle. For example, if revenue
expenditure is treated as capital expenditure or vice versa.
2. Clerical Errors
These errors can again be sub-divided as follows:
(i) Errors of omission
When a transaction is either wholly or partially not recorded
in the books, it is an error of omission. It may be with regard to omission to
enter a transaction in the books of original entry or with regard to omission to
post a transaction from the books of original entry to the account concerned in
the ledger.
(ii) Errors of commission
When an entry is incorrectly recorded either wholly or
partially-incorrect posting, calculation, casting or balancing. Some of the
errors of commission effect the trial balance whereas others do not. Errors
effecting the trial balance can be revealed by preparing a trial balance.
(iii) Compensating errors
Sometimes an error is counter-balanced by another error in
such a way that it is not disclosed by the trial balance. Such errors are called
compensating errors.
From the point of view of rectification of the errors, these
can be divided into two groups :
(i) Errors affecting one account only, and
(ii) Errors affecting two or more accounts.
Errors affecting one account
Errors which affect can be :
(a) Casting errors;
(b) error of posting;
(c) carry forward;
(cl) balancing; and
(e) omission from trial balance.
Such errors should, first of all, be located and rectified.
These are rectified either with the help of journal entry or by giving an
explanatory note in the account concerned.
Rectification
Stages of correction of accounting errors
All types of errors in accounts can be rectified at two
stages:
(i) before the preparation of the final accounts; and
(ii) after the preparation of final accounts.
Errors rectified within the accounting period
The proper method of correction of an error is to pass
journal entry in such a way that it corrects the mistake that has been committed
and also gives effect to the entry that should have been passed. But while
errors are being rectified before the preparation of final accounts, in certain
cases the correction can't be done with the help of journal entry because the
errors have been such. Normally, the procedure of rectification, if being done,
before the preparation of final accounts is as follows:
(a) Correction of errors affecting one side of one account
Such errors do not let the trial balance agree as they effect only one side of
one account so these can't be corrected with the help of journal entry, if
correction is required before the preparation of final accounts. So required
amount is put on debit or credit side of the concerned account, as the case
maybe. For example:
(i) Sales book under cast by Rs. 500 in the month of January.
The error is only in sales account, in order to correct the sales account, we
should record on the credit side of sales account 'By under casting of. sales
book for the month of January Rs. 500".I'Explanation:As sales book was under
cast by Rs. 500, it means all accounts other than sales account are correct,
only credit balance of sales account is less by Rs. 500. So Rs. 500 have been
credited in sales account.
(ii) Discount allowed to Marshall Rs. 50, not posted to
discount account. It means that the amount of Rs. 50 which should have been
debited in discount account has not been debited, so the debit side of discount
account has been reduced by the same amount. We should debit Rs. 50 in discount
account now, which was omitted previously and the discount account shall be
corrected.
(iil) Goods sold to X wrongly debited in sales account.
This error is effecting only sales account as the amount
which should have been posted on the credit side has been wrongly placed on
debit side of the same account.
For rectifying it, we should put double the amount of
transaction on the credit side of sales account by writing "By sales to X
wrongly debited previously."
(iv) Amount of Rs. 500 paid to Y, not debited to his personal
account. This error of effecting the personal account of Y only and its debit
side is less by Rs. 500 because of omission to post the amount paid. We shall
now write on its debit side. "To cash (omitted to be posted) Rs.
500.
Correction of errors affecting two sides of two or more
accounts
As these errors affect two or more accounts, rectification of
such errors, if being done before the preparation of final accounts can often be
done with the help of a journal entry. While correcting these errors the amount
is debited in one account/accounts whereas similar amount is credited to some
other account/ accounts.
Correction of errors in next accounting period
As stated earlier, that it is advisable to locate and rectify
the errors before preparing the final accounts for the year. But in certain
cases when after considerable search, the accountant fails to locate the errors
and he is in a hurry to prepare the final accounts, of the business for filing
the return for sales tax or income tax purposes, he transfers the amount of
difference of trial balance to a newly opened 'Suspense Account'. In the next
accounting period, as and when the errors are located these are corrected with
reference to suspense account. When all the errors are discovered and rectified
the suspense account shall be closed automatically. We should not forget here
that only those errors which effect the totals of trial balance can be corrected
with the help of suspense account. Those errors which do not effect the trial
balance can't be corrected with the help of suspense account. For example, if it
is found that debit total of trial balance was less by Rs. 500 for the reason
that Wilson's account was not debited with Rs. 500, the following rectifying
entry is required to be passed.
Difference in trial balance
Trial balance is affected by only errors which are rectified
with the help of the suspense account. Therefore, in order to calculate the
difference in suspense account a table will be prepared. If the suspense account
is debited in' the rectification entry the amount will be put on the debit side
of the table. On the other hand, if the suspense account is credited, the amount
will be put on the credit side of the table. In the end, the balance is
calculated and is reversed in the suspense account. If the credit side exceeds,
the difference would be put on the debit side of the suspense
account.
Effect of Errors of Final Accounts
1. Errors effecting profit and loss account
It is important to note the effect that an en-or shall have
on net profit of the firm. One point to remember here is that only those
accounts which are transferred to trading and profit and loss account at the
time of preparation of final accounts effect the net profit. It means that only
mistakes in nominal accounts and goods account will effect the net profit. Error
in the these accounts will either increase or decrease the net profit.
How the errors or their rectification effect the
profit-following rules are helpful in understanding it :
(I) If because of an error a nominal account has been given
some debit the profit will decrease or losses will increase, and when it is
rectified the profits will increase and the losses will decrease. For example,
machinery is overhauled for Rs. 10,000 but the amount debited to machinery
repairs account -this error will reduce the profit. In rectifying entry the
amount shall be transferred to machinery account from machinery repairs account,
and it will increase the profits.
(il) If because of an error the amount is omitted from
recording on the debit side of a nominal account-it results in increase of
profits or decrease in losses. The rectification of this error shall have
reverse effect, which means the profit will be reduced and losses will be
increased. For example, rent paid to landlord but the amount has been debited to
personal account of landlord-it will increase the profit as the expense on rent
is reduced. When the error is rectified, we will post the necessary amount in
rent account which will increase the expenditure on rent and so profits will be
reduced.
(iil) Profit will increase or losses will decrease if a
nominal account is wrongly credited. With the rectification of this error, the
profits will decrease and losses will increase. For example, investments were
sold and the amount was credited to sales account. This error will increase
profits (or reduce losses) when the same error is rectified the amount shall be
transferred from sales account to investments account due to which sales will be
reduced which will result in decrease in profits (or increase in losses).
(iv) Profit will decrease or losses will increase if an
account is omitted from posting in the credit side of a nominal or goods
account. When the same will be rectified it will increase the profit or reduce
the losses.
For example, commission received is omitted to be posted to
the credit of commission account. This error will decrease profits ( or increase
losses) as an income is not credited to profit and loss account. When the error
will be rectified, it will have reverse effect on profit and loss as an
additional income will be credited to profit and loss account so the profit will
increase ( or the losses will decrease).
If due to any error the profit or losses are effected, it
will have its effect on capital account also because profits are credited and
losses are debited in the capital account and so the capital shall also increase
or decrease. As capital is shown on the liabilities side of balance sheet so any
error in nominal account will effect balance sheet as well. So we can say that
an error in nominal account or goods account effects profit and loss account as
well as balance sheet.
2. Errors effecting balance sheet only
If an error is committed in a real or personal account, it
will effect assets, liabilities, debtors or creditors of the firm and as a
result it will have its impact on balance sheet alone. because these items are
shown in balance sheet only and balance sheet is prepared after the profit and
loss account has been prepared. So if there is any error in cash account, bank
account, asset or liability account it will effect only balance sheet.
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