Accounting (0452) | Correction of errors

👋 Welcome, Future Accounting Detectives!

Welcome to the chapter on Correction of Errors! Don't worry, even the best bookkeepers make mistakes. Your job here is to become the detective who finds those mistakes and fixes them neatly.

This topic is crucial because verifying (checking) accounting records ensures the financial statements (like the Income Statement and Statement of Financial Position) show a true and fair view of the business. An error-free record is a reliable record!

Section 1: The General Journal – The Tool for Correction

1.1 Why We Need a Formal Correction Method

In real-world accounting, you cannot just grab an eraser and change the numbers in the ledger. Every correction must be documented clearly so there is a verifiable record (an audit trail).

The official accounting document used to record these corrections is the General Journal (or simply the Journal).

• Journal entries follow the double entry rule (Debit = Credit).
• Each entry must include a brief explanation, known as a narration, detailing what the error was and what the correction achieves.

1.2 Step-by-Step: Correcting Errors using the Journal

The General Journal entry is the legal command to the bookkeeper to change the ledger accounts.

1. Identify the error: Figure out what was debited and credited wrongly (or omitted).
2. Determine the required correction: Figure out what *should* have been debited and credited.
3. Prepare the Journal entry: Create a new double entry that cancels out the effect of the mistake and/or makes the required correct entry.
4. Write the Narration: Explain the correction clearly.

Section 2: Errors That DO NOT Affect the Trial Balance

The Trial Balance (TB) lists all the ledger balances and checks if total debits equal total credits. Surprisingly, many serious errors still allow the TB to balance! This is because the error usually affects two accounts equally (maintaining the Duality principle).

These errors must be corrected using a simple General Journal entry, without using a Suspense Account.

Memory Aid: The Six Errors that Keep the TB Balanced (OOP CCC)

You must be able to identify and explain these six types of errors (3.1).

1. Error of Omission

This happens when a transaction is completely forgotten and not recorded in the books at all.
Example: A cash sale of $500 was not recorded.
Correction: Record the transaction correctly using the Journal (Dr Cash, Cr Sales).

2. Error of Commission

The entry is posted to the correct side (Dr or Cr) and the correct class of account (e.g., an Asset), but to the wrong person’s or entity’s account.
Example: Goods sold to *Ali* were debited to the account of *Amir*. (Both Ali and Amir are Trade Receivables, so the total Trade Receivables figure might still look correct initially).
Correction: Dr Amir’s account to reverse the wrong entry, Cr Ali’s account for the correct entry.

3. Error of Principle

The entry is posted to the wrong class of account, violating an accounting principle (e.g., distinguishing between capital and revenue).
Example: The purchase of a new machine (Capital Expenditure) was debited to the Repairs account (Revenue Expenditure).
Correction: Dr Machinery (correct), Cr Repairs (reverse the wrong debit).

4. Compensating Error

Two different errors cancel each other out, making the TB balance.
Example: Sales account was overstated by $100 (Cr too high) AND Purchases account was overstated by $100 (Dr too high). The total Debits and Credits are still equal.
Correction: Dr Sales (to reduce the credit), Cr Purchases (to reduce the debit).

5. Error of Complete Reversal (or Transposition of Accounts)

The correct accounts are used, but the Debit and Credit entries are swapped.
Example: Bought goods on credit for $800. Correct: Dr Purchases, Cr Trade Payables. Error: Dr Trade Payables, Cr Purchases.
Correction: You need to double the amount to fix this. To correct the $800 error, you need to Dr Purchases $1,600 and Cr Trade Payables $1,600. Why? $800 reverses the mistake, and another $800 puts the correct entry in.

6. Error of Original Entry

The transaction amount is calculated or recorded incorrectly in the book of prime entry, and this incorrect amount is then posted correctly (Dr and Cr) to the ledger accounts.
Example: An invoice for $270 was entered in the Sales Journal as $720. Both Sales and Trade Receivables accounts were posted with $720.
Correction: The accounts are both overstated by $450 ($720 - $270). Dr Sales $450, Cr Trade Receivables $450.

Section 3: Errors That DO Affect the Trial Balance and The Suspense Account

3.1 What is a Suspense Account?

If the Trial Balance (TB) fails to balance (Total Debits ≠ Total Credits), it means an error has occurred that has affected only *one side* of the double entry system, or that the amounts used are unequal.

To finalize the TB and proceed with preparing the financial statements, the accountant opens a temporary account called the Suspense Account.

The Suspense Account is simply used to temporarily hold the difference between the debit and credit columns of the unbalanced TB.

• If the TB Debits > TB Credits, the difference is placed on the Credit side of the Suspense Account.
• If the TB Credits > TB Debits, the difference is placed on the Debit side of the Suspense Account.

Think of the Suspense Account as an accounting "holding cell" for the missing money. As soon as the actual error is found and corrected, the Suspense Account should become zero (closed).

3.2 Common Errors Requiring a Suspense Account

These errors are usually single-sided errors, where one account was posted incorrectly or completely missed.

• Posting only the debit entry or only the credit entry.
• Posting an entry to the correct side but with the wrong amount.
• Error in addition (casting) in a ledger account or a book of prime entry.
• Error in calculating the balance of a ledger account.
• Transferring a ledger balance to the TB with the wrong amount or on the wrong side.

3.3 Correcting Errors Using the Suspense Account

When you find an error that caused the TB imbalance, your journal entry must involve two accounts:

1. The Correct Ledger Account (the account that was posted wrongly or missed).
2. The Suspense Account (used to clear the temporary balance).

Example of Correction with Suspense Account:

Error: Rent paid, $400, was correctly debited to the Rent Expense account, but no credit entry was made. (Assuming the TB credits were short by $400).

Analysis: The missing credit entry is for Cash/Bank ($400). The Suspense Account currently has a credit balance of $400 (to make the TB balance). We must now:
1. Credit the Cash/Bank account (the account that should have been credited).
2. Debit the Suspense Account (to clear its balance).

Journal Entry:
Dr Suspense Account $400
Cr Bank/Cash Account $400
(Narration: Correction for rent payment omitted from the Cash Book credit side.)

The Outcome: The $400 debit closes the Suspense Account, and the $400 credit corrects the Cash/Bank account. The books are now correct.

Section 4: Impact of Error Correction on Financial Statements

After correcting errors, especially those discovered after a preliminary Income Statement has been drawn up, you must consider the effect on two critical figures:

1. Profit for the Year (from the Income Statement)
2. Owner’s Equity and Assets/Liabilities (from the Statement of Financial Position)

4.1 Adjusting the Profit for the Year

Profit is calculated as Revenue minus Expenses. Any correction involving a revenue or expense account will affect the profit.

• If the correction requires a Debit to an Expense account (or a Credit to a Revenue account), profit DECREASES.
• If the correction requires a Credit to an Expense account (or a Debit to a Revenue account), profit INCREASES.

Step-by-Step Profit Adjustment:

Let's say the original profit calculated was $10,000.

Example 1: Correction of Principle. Electricity repair cost of $500 was wrongly debited to the Fixtures account (an Asset).
Correction Journal: Dr Repairs Account (Expense) $500, Cr Fixtures Account (Asset) $500.
Effect on Profit: Repairs (Expense) increases by $500. Profit DECREASES by $500.
New Profit: \( \$10,000 - \$500 = \$9,500 \)

Example 2: Correction of Commission. Rent received of $1,000 was credited to the Interest Received account.
Correction Journal: Dr Interest Received (Revenue) $1,000 (to reverse the wrong entry), Cr Rent Received (Revenue) $1,000.
Effect on Profit: This correction moves revenue from one revenue account to another. It does NOT change the total revenue figure, so Profit is UNAFFECTED.

4.2 Effect on the Statement of Financial Position (SFP)

The SFP is affected whenever the correction involves an asset, a liability, or owner's equity (Capital).

• The most common way owner’s equity is affected is through the change in the Profit for the Year, which is transferred to capital.
• If correcting an error increases profit, Owner's Equity increases.
• If correcting an error involves an asset/liability account, that specific figure on the SFP must be adjusted.

Example of SFP Effect:

Using Example 1 above (Repair wrongly debited to Fixtures):
1. Fixtures (Non-Current Asset) was $500 too high. The correction requires a credit to Fixtures, reducing the Asset value.
2. Profit for the Year decreased by $500, meaning Owner's Equity (Capital) will decrease by $500.
(Notice that the total decrease in Assets ($500) equals the total decrease in Owner's Equity ($500), keeping the Accounting Equation (A = L + E) balanced!)