Correction of errors
This chapter explains how to identify and correct accounting errors that occur when transactions are recorded and posted to the general ledger. You’ll see two broad groups of errors:
- errors detected by the trial balance (because debits and credits don’t agree)
- errors not detected by the trial balance (because debits and credits still agree, even though something is wrong)
To get the most from this chapter, you need to be comfortable with double-entry bookkeeping and posting transactions to the correct general ledger accounts. That foundation is what lets you spot what went wrong and choose the right correction.
Learning objectives
By the end of this chapter, you should be able to:
- Identify the types of error which may occur in accounting systems.
- Identify errors that would be highlighted by the extraction of a trial balance and those that would not.
- Prepare manual journal entries to correct errors.
Errors in trial balance
When people record and post transactions to the general ledger, mistakes can happen. In practice, we often classify accounting errors into two categories:
- those detected by the trial balance (causing imbalance)
- those not detected by the trial balance (keeping it balanced despite being incorrect).
Errors detected by the trial balance
These errors break the double-entry principle. Because the debit and credit sides don’t match, the trial balance won’t balance.
Errors not detected by the trial balance
These errors do not break the equality of total debits and total credits. The trial balance still balances, even though the accounting records are wrong. That’s why the trial balance can’t detect these errors.
Passing journal entries to correct errors
Once you’ve identified an error, you correct it by passing a journal entry that follows double-entry bookkeeping. To prepare the correct journal entry, identify:
- The nature of error
- The general ledger accounts affected by the error (where one of the general ledger accounts is unknown, suspense accounts become applicable).
- The amounts involved
- The direction of the error (overstatement or understatement).
Let’s apply these steps to the illustrations below. Illustration 1: Correction of errors
A company purchased equipment for $75,000 on credit and recorded it as a debit to office supplies expense.
Apply the procedures above to the question and pass the journal entry to correct it.
Now compare your answer to this.
Analysis of the question:
- The expenditure is a capital expenditure, hence, must be recorded in the asset general ledger with the corresponding entry in the payable general ledger. Though the payable general ledger was recorded correctly, the expenditure was wrongly debited to the expense general ledger.
- The nature of the error is that an expense general ledger was wrongly debited instead of an asset general ledger. Both general ledgers (i.e., equipment and office supplies expense) are known, hence, no suspense account would be used in the error correction.
- The amount involved is $75,000 where the office supplies general ledger is overstated and equipment general ledger understated.
- Based on this analysis, the journal entry to be passed to correct the error will be to decrease the office supplies expense and increase the equipment general ledger account.
This is given as:
| Debit | Credit | |
|---|---|---|
| Equipment | $75,000 | |
| Office supplies expense | $75,000 | |
| To reclassify equipment purchase incorrectly recorded as office supplies expense |
Illustration 2: Correction of Errors
For each of the transactions that follow, you are required to identify the type of error and prepare the journal entry to correct the error.
- During a review of the accounting records, it was discovered that a $12,500 credit sale was recorded as $21,500.
Do you know the answer?
The error committed is an Error of Original Entry. Journal entry to correct the error will be:
Dr. Sales/revenue $9,000
Cr. Accounts Receivable $9,000
To correct the overstatement of the credit sale recorded as $21,500 instead of $12,500
- A company paid $8,400 for a 12-month insurance policy, but the entire amount was incorrectly recorded as an insurance expense. It has been 3 months since the policy began.
Do you know the answer?
The error committed is an Error of Principle. In this case, the company recorded the entire $8,400 insurance payment as an expense, instead of allocating $2,100 (3/12 × $8,400) as an expense and treating $6,300 (9/12 × $8,400) as a prepaid insurance (asset). Journal entry to correct the error will be:
Dr. Prepaid Insurance $6,300
Cr. Insurance Expense $6,300
To reclassify the unexpired portion of insurance premium after 3 months: $8,400 × 9/12 = $6,300
- The accountant discovered that a payment of $3,750 received from a customer, Johnson Inc., was credited to the account of a different customer, Smith Co. Journal entry to correct the error will be:
Do you know the answer?
That is an Error of Commission. Here, both Johnson Inc. and Smith Co. are accounts receivable (customers). The payment was posted to the wrong customer’s account, but the total debtors control (trade receivables) balance remains correct. Journal entry to correct the error will be:
Dr. Smith Co. (Accounts Receivable) $3,750
Cr. Johnson Inc. (Accounts Receivable) $3,750
To correct customer payment incorrectly credited to Smith Co. instead of Johnson Inc.
- A company’s bookkeeper failed to record accrued wages of $14,200 at the end of the fiscal year.
Do you know the answer?
That is an Error of Omission. In this case, the accrued wages of $14,200 were not recorded at all. Journal entry to correct the error will be:
Dr. Retained Earnings $14,200
Cr. Wages Payable $14,200
To record accrued wages from the previous period that were omitted
- A company sold equipment with a cost of $45,000 and accumulated depreciation of $30,000 for $18,000 cash. The transaction was recorded as a debit to cash for $18,000 and a credit to equipment disposal gain for $18,000, with no entries for the removal of the equipment and its accumulated depreciation.
Do you know the answer?
That is an Error of Omission (partial omission).
In this case, only the cash received ($18,000) and gain on disposal ($18,000) were recorded, but the removal of the equipment cost ($45,000) and its accumulated depreciation ($30,000) were omitted. Journal entry to correct the error will be:
Dr. Accumulated Depreciation $30,000
Dr. Loss on Disposal of Equipment $15,000
Cr. Equipment $45,000
To complete the recording of equipment disposal by removing the cost and accumulated depreciation from the books and recognizing the correct gain/loss
First, derecognize the equipment cost by crediting the ledger account and debiting the accumulated depreciation general ledger account. The correct gain/loss calculation is the difference between the proceeds (i.e., $18,000) and the carrying amount of the equipment ($45,000 - $30,000 = $15,000).
Since the company incorrectly recorded an $18,000 gain (rather than the correct $3,000 gain), the correction entry would need to reduce the $18,000 to $3,000 by debiting the general ledger account $15,000.