It is said that one of the best ways to learn is through making mistakes.
Unfortunately, when it comes to a set of accounts there is very little room for error, and the impact of a simple bookkeeping mistake can be significant and far reaching. In this three part series on errors, we are therefore going to have a look at identifying and correcting errors.
Let’s start by thinking about where errors are likely to be found in a set of accounts. The unfortunate answer is, that they can be anywhere and everywhere. I know that is not very helpful, but it is the reason why there are so many checks and reconciliations in accounting systems that highlight discrepancies, so that mistakes can be identified and rectified as soon as possible. It is also the reason why accounting packages are favoured over manual systems as automation reduces the opportunities for human error.
The last check
Despite all the precautions and safeguards built into the bookkeeping processes, mistakes inevitably still occur. The trial balance is the last check before year-end adjustments are made and final accounts prepared, and it plays a crucial role in ensuring the accuracy of the ledger account balances. However, whilst a trial balance that balances is a good indication of the accuracy of the accounts, it does not mean they are error free, just that the total debits are equal to the total credits. Errors in the accounts fall into two categories, those that are disclosed by the trial balance and those that are not.
When we say ‘errors that are not disclosed on the trial balance’ what we mean is, that they do not cause an imbalance between the debit and credit columns and therefore we are not alerted to a problem. These types of errors are, in reality, very hard to spot if they are not picked up by checks earlier in the bookkeeping process. This means that it is of vital importance that we are aware of them and understand their impact. Let’s look at each in turn:
An error of original entry
An error of original entry occurs when a figure is entered into the accounts incorrectly. For example, an invoice for a cash sales of £108 is posted as £810 to the debit side of the bank account and the credit side of the sales account. The amount is incorrect but the correct accounts have been used and the entries have been made on the correct sides. The reason why the figure is incorrect is not the important issue in relation to the error type, the foremost point about an error of original entry, is that both the debit and credit entries are made for the same incorrect amount. The impact of this error would be that the:
- bank account balance is overstated by £702.
- sales turnover is overstated by £702.
- profit figure will be too high due to the inflated sales figure which will lead to an increased tax liability.
- business will look in a better position than it is because its assets are overstated.
An error of principle
An error of principle is when entries are made into the wrong type of account. For example, the cost of buying some new machinery is posted to the ‘maintenance and repairs’ account instead of the ‘machinery at cost’ account. This type of error means that figures will end up in a fundamentally different category of account, in this case, an expense instead of an asset account. There can be very serious implications when an error of principle is made. The impact in this example would be that the:
- maintenance and repairs account is overstated, which will result in a higher total expenses figure on the statement of profit and loss and therefore a lower profit figure and the potential for tax to be underpaid.
- machinery at cost account is understated and that will lead to the statement of financial position showing an inaccurate position of the business’s worth as the value of its new asset is missing.
An error of commission
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. For example, if the cost of buying some new machinery is posted to the ‘fixtures and fitting at cost’ account instead of the ‘machinery at cost’ account. There is still a mistake, as there was in the error of principle above, however, the consequences are not quite as serious this time. The impact now would be that the:
- fixtures and fittings at cost account is overstated
- machinery at cost account is understated
- the profit figure is unaffected
- the statement of financial position is accurate as the overall value of the business’s assets is correct
In part two we will look at the other three errors that are not disclosed by the trial balance and start to look at how to use our knowledge of the effect errors have on the trial balance, to help us correct mistakes.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.