F. 4 BAFS Correction of Errors wch/3.
Correction of errors
Basic approach in correcting errors:
Step 1: Find out the original entries already made
Step 2: Compare with correct entries that should be made
Step 3: Cancel the wrong entries made (i.e. make a Dr entry to cancel a Cr entry and vice versa)
Step 4: Make the correct entries omitted
N.B. Step 3 and step 4 can be combined (i.e. just enter the amount overstated or understated).
Errors not affecting the agreement of the trial balance:
error of omission
error of commission
error of principle
compensating error
error of original entry
complete reversal of entries
N.B. If the nominal a/cs (revenues and expenses) had been closed (i.e. profit and loss account had been prepared / net profit
or loss had been found), correction should be made in the profit and loss a/c instead of the nominal a/cs (i.e. adjust profit and
loss a/c, not revenues and expenses a/cs). If only the draft net profit is given, correction should be made in the nominal a/cs.
Some special transactions:
Closing inventory overstated or understated:
Overstated: Understated:
Dr Profit and loss Dr Inventory
Cr Inventory Cr Profit and loss
Goods on sale or return:
A wholesaler sells goods to a retailer but allow him to return the goods with no obligation (if he cannot sell them).
The goods belong to the wholesaler (supplier) until they are sold by the retailer (customer) and any unsold goods
should be included in closing inventory of the wholesaler (supplier).
Example:
Chan invoices $1 500 of goods to Lee on a sale or return basis on 10 Dec 20-7. Accounting entries (Dr Debtors and Cr
Sales) have been made when goods are sent. The goods had cost Chan $600. At 31 December, Lee confirmed the
acceptance of 40% of the goods sent and he had sold these goods for $750. Chan has not included any goods sent to Lee in
closing inventory but Lee has included goods from Chan in closing inventory.
Correcting entries for supplier: Correcting entries for customer:
Chan’s books Lee’s books
Dec. 31 Dr Sales 900 Dr Profit and loss 900
Cr Lee 900 Cr Inventory 900
(60% of goods would be returned; $1500x60%) (Goods from Chan should be excluded; $1500x60%)
Dr Inventory 360
Cr Profit and loss 360
(Goods held by Lee should be included; $600x60%)
Free samples:
In supplier’s books:
Case 1: Cost of free samples is not significant.
No entry is required.
Case 2: Cost of free samples is significant.
Dr Selling expenses / Promotional expenses
Cr Purchases
In customer’s books:
Free samples are not supposed to be for sale and should not be treated as inventory. If the customer had included the
free samples in inventory, the following correcting entries should be made:
Dr Profit and loss
Cr Inventory
1
F. 4 BAFS Correction of Errors wch/3.2
Credit card sales:
equivalent to cash sales except that there is a cost, a monthly commission charge
Dr Credit card company
Cr Sales
Dr Bank
Selling expense/commission
Cr Credit card company
Errors affecting the agreement of the trial balance:
When the trial balance does not agree, entries and postings have to be checked to discover where the error lies.
If the urgency of the situation does not allow time to find the difference, a suspense account may be used as a
temporary measure to bring the trial balance into balance.
The suspense account may provide a check for the accuracy of the correcting entries. To correct errors affecting
trial balance agreement, a correcting entry has to be made in the suspense account. If all the correcting entries
are made properly, their net result should be just enough to offset the balance of the suspense account.
Examples:
errors in recording a transaction in the ledger
e.g. omitting a debit or credit posting, posting a debit entry as a credit entry (or vice versa), casting error
errors in balancing off accounts
e.g. incorrectly computing a balance, entering a balance in the wrong column
errors in preparing the trial balance
N.B. Only a single entry in the suspense a/c is required to correct this kind of errors. The trial balance is not a
ledger a/c and therefore no journal entry should be made to correct it,
e.g.
Errors Correcting entries
Omitting a debit balance (e.g. cash) in the trial balance Cr Suspense (No debit entry)
Overcasting the debit column of the trial balance Dr Suspense (No credit entry)
Incorrectly recording a smaller amount of an a/c balance on Dr Suspense (No credit entry)
the credit column of the trial balance
Incorrectly recording a debit balance (e.g. cash) in the trial Cr Suspense (No debit entry)
balance as a credit balance (Note: amount doubled)
Effect of errors on reported profits:
Only errors affecting profit and loss a/c (or income statement) would affect reported profits; others would affect
statement of financial position figures.
To find the corrected net profit:
i) identify the entries that will affect net profit
ii) add credit entries to the original net profit
iii) subtract debit entries from the original net profit
Effect of errors on working capital (net current assets) and statement of financial position:
If the errors affect current assets and/or current liabilities, working capital will also be affected.
Current assets Current liabilities Working capital
Increase -- Increase
Decrease -- Decrease
-- Increase Decrease
-- Decrease Increase
For those errors not affecting profit and loss, they will affect items in the statement of financial position. A
revised statement has to be prepared with the corrected net profit.
N.B. Closing inventory will affect both income statement (profit and loss) and statement of financial position
