In part one of this series about identifying and correcting errors, we looked at the fact that the trial balance makes a last stand against mistakes before the ledger account balances are used to prepare a set of final accounts.
We also highlighted the problem that even when our trial balance balances, this do not unfortunately guarantee that the accounts are error free, because whilst the trial balance discloses one set of errors, there is another set that it does not. We considered three of the errors that do not cause an imbalance between the debit and credit columns of the trial balance:
- An error of original entry occurs when a figure is entered into the accounts incorrectly.
- An error of principle is when entries are made into the wrong type of account.
- An error of commission is similar to an error of principle as entries are made into the wrong account but this time in the right category is used.
Let’s now look at the remaining three:
An error of omission
An error of omission is made when a transaction is complete left out of the accounts. For example, it could occur if an email, that has an invoice attached, is deleted before the invoice has been downloaded and processed. The overall debits and credits in the trial balance will balance because none will have been made for the omitted transaction. The impact of an error of omission will depend of the value of what has been missed. If, for example, a receipt for some stamps has been omitted, then the low value of the transaction is likely to make it immaterial to the overall integrity of the accounts. However, if a sales invoice is not processed, then the impact will be much more significant as a customer will not have been charged for goods or services and the business will miss out on sales revenue.
An error of reversal
An error of reversal occurs when a transaction is posted but the debits and credits are entered into the accounts the wrong way round. For example, a cash purchase for £100 is posted as:
The problem will be undisclosed by the trial balance as the debit and credit values of the transaction are the same. However, the problem still remains and has consequences. The bank balance will have been increased rather than reduced and the purchase will in effect be treated as a purchases return, decreasing the expenses instead of increasing them.
A compensating error
A compensating error needs two mistakes to be made that cancel each other out. Whilst the chances of compensating errors happening in reality are pretty low, they are possible. For example, if both the discounts allowed and discounts received accounts are undercast by £20 then, as the first has a debit balance and the latter a credit balance, the fact that they are both short by £20 will not show up on the trial balance.
Knowing the effect errors have on the trial balance is the first step to being able to identify how to correct mistakes. When we are faced with an error to rectify, the first question to ask should be:
Is the trial balance unbalanced by what has happened?
If the answer is no, then the culprit will be one of the six undisclosed errors and will have a specific name. Whilst these types of errors are tricky to find, once identified the journal needed to correct them is usually a simple two line journal that removes the transaction from the wrong account and puts it in the right one.
Let’s correct the error of principle from part one, where the cost of buying some new machinery was posted to the maintenance and repairs account instead of the machinery at cost account. The entries will not cause an imbalance on the trial balance as the debit and credit for the transaction match:
The bank account posting is correct so all that needs to happen is the maintenance and repairs account needs £10,000 removing and the machinery at cost account needs £10,000 entering. The journal required is:
If we look at the error commission, where say £500 of new machinery was posted to the fixtures and fitting at cost account instead of the machinery at cost account, we again know the debit and credit for the transaction match so the error will not be disclosed by the trial balance. The correction will be:
The result of the correction will be to cancel out the incorrect posting in the fixtures and fittings account and correctly show the value of the asset in the machinery at cost account:
Now we have considered the set of errors not disclosed by the trial balance we can move on to the set that are. In contrast to the errors not disclosed by the trial balance because they do not cause an imbalance, the reason that other errors are disclosed by the trial balance is because the debits and credits do not match. Any transaction that has an imbalance between the total debits and total credits will have the same effect on the trial balance. Examples include:
- single sided entries, where only the debit or credit entry is made
- double sided entries, where two debits or two credits are posted
- entering different amounts for the debit and credit
- calculation errors, where the debits and credits have been entered correctly but then a mistake in the calculation of the balance is made
- balance errors, where the account and balance are correct but the balance is transferred incorrectly to the trial balance
- omission of an account balance from the trial balance
In part three we will return to the question of whether the effect of an error causes an imbalance in the trial balance and look at what to do if the answer is yes!
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.