Financial AccountingRectification of Errors

Rectification of Errors in Accounting

Accounting Errors need to be rectified upon identification during the review of accounting records. Rectification will depend upon the nature and impact of the error on trial balance and financial statements.

Based on the effect of the agreement on the trial  balance, Accounting errors can be classified into the following two categories

1.    One-sided Accounting Errors

The double-entry convention of accounting requires that for each transaction, a debit entry shall be recorded with an equal credit entry into the books of accounts. If any portion of the accounting entry is omitted from recording, it ultimately will result in a disagreement on the trial balance. 

At the time of preparation of Trial Balance,  if the Debit column is not equal to the total of the credit column, this implies there is a one-sided accounting error, which needs to be identified and rectified. Omission and transposition errors are examples of one-sided accounting errors. 

One-sided accounting errors are difficult to deduct when accounting is being done manually, however modern accounting systems can prevent these types of errors.

I.    In computerized accounting systems all the Daybooks/ journals are automatically updated and posted into the ledger unlike the manual accounting system, where the summary of transactions needed to be manually recorded into each ledger. Adding up the transactions in the daybook and then posting the total into the concerned ledger may cause errors difficult to be traced. 

II.     While posting the entries from General Journal into the ledgers, the computerized accounting system does not permit any unbalanced and unequal accounting entries from recording into the records. 

Besides the above advantages of computerized accounting systems in preventing errors, one-sided accounting errors can still occur if journals and ledgers are not properly integrated and mapped to the trial balance. However, such reasons for errors can easily be identified and sorted in modern computer applications.

One-sided Errors can be prevented, identified, and rectified by ensuring completeness (i.e. every single transaction has been recorded into the book of accounts). Further arithmetical accuracy of the amounts being entered into the books of account shall be reviewed and ensured.

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2.    Errors which Does not affect the agreement of trial balance

Examples of such errors are Complete omission, commission, and reversal of accounting entries, and error of original entry are two sides of error that do not have any impact on the agreement to trial balance. 

Two-sided errors are difficult to be prevented and traced and there is no effect on the agreement of trial balance because of its existence, therefore such errors may remain hidden. Two-sided errors or errors of a complete transaction can be identified by performing reconciliation between accounts and different statements from external parties like bank statements, and statements of accounts from customers and suppliers. 

Another way to identify such errors is by sending the statement of accounts to customers and suppliers and asking for the confirmation of the balance in their book of accounts. In case of discrepancies, inquiries are made and most of the time errors on either side are Identified and rectified accordingly. 

Rectification of errors

Accounting errors may become known at two stages;

-Accounting error before the preparation and reporting of final accounts

-Accounting error before the preparation and reporting of final accounts

Rectification of One-sided Accounting Errors

The procedure for rectification of one-sided errors will depend on the time when the error was identified. 

If the error was identified before the finalization of accounts and reporting financial statements to the stakeholders, it will be rectified simply by posting the difference/error into the concerned ledger and giving an explanatory note as a description. Let us assume the illustration used in the previous section. 

For example, it was identified that while posting the cash sales of $ 500 to Mr. A from the sales daybook, only the debit entry in the cash book was posted, while the credit entry of $500 in the sales ledger was omitted.

In such a scenario, the omitted entry of $500 will be posted on the credit side of the sales ledger with the explanation.

In case the final account has been closed and financial statements reported any error became known or identified it will be rectified by posting a journal entry with the amount of difference/error into the relevant ledger and the same amount will be posted into The suspense account on the opposite side.

In the event that the above-demonstrated omission of $500 was identified after the reporting of financial statements, the rectification will require recording of the following Journal Entry;

Dr.        Suspense Account         $500

Cr.            Retained Earning w.r.t Sales Ledger            $500

Being posted the one-sided error of omission.

The reason for the posting of counter entry into retained earnings is to reflect the fact that because of this error sales ledger and ultimately retained earnings of last year were understated. 

Identification of one-sided error may entail the following two reasons;

  • Last year there was a balance in the suspense account which could not have been rectified till the preparation of Financial Statements. In which case identification shall reduce the balance of the suspense account. 
  • In case there was no balance in the suspense account last year, then the identification of one-sided errors implies the existence of compensating errors in last year’s accounting record, which needs to be examined and rectified. 

Rectification of Two-sided Accounting Errors

In any case, whether identified before or after the closing of accounts and reporting Financial Statement, two-sided errors will be rectified by recording accounting entry through General Journal and posting it to the concerned ledgers. 

However, in case material and significant amounts are involved, the accounting entry is disclosed as an adjustment in the opening balance of the ledgers. 

In case the rectification required posting of amounts in nominal accounts (e.g. ledger accounts with balances reported in Profit and Loss statements), the amounts will be posted into the retained earning instead of the Ledger account. This is to reflect the over/understatement of profit/ loss and ultimately retained earnings due to the error in the previous year.

Nevertheless, the nature of the journal entry will be the same and amounts will be posted on the appropriate side of the relevant ledger.

For example, credit sales of $500 to Mr. A was correctly posted to Sales and receivable Ledger Control accounts but instead of posting a credit entry to Mr. A, Mr. B was credited in the subsidiary ledger account.

Identification of this error, whether before or after the closing of accounts and reporting of financial statements, following adjusting journal entry will be recorded;

Dr.        Mr.B        $500

Cr.             Mr. A        $500

Being posted the rectification of commission error

This correcting entry will reduce the balance of Mr. B and increase the credit balance of Mr.A

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