0452 · 3.2Corrections of errors

How errors affect trial balances

0:00Nora’s Stationery can produce matching trial balance totals and still have incorrect records. A payment might be recorded in the wrong account, or a transaction might be missing completely. This video covers correcting errors using journal entries, and the use of a suspense account as a temporary measure to balance the trial balance. It then shows how to correct errors using a suspense account. Finally, we adjust the profit for the accounting period and show the effect of each correction on a statement of financial position.

0:26Double entry means every transaction is recorded as a debit in one account and a credit of the same amount in another. A trial balance is a list of ledger balances on a particular date. Matching totals check the equality of debits and credits, rather than the accuracy of every account. An equal error on both sides therefore leaves the totals unchanged. Assets are resources owned or controlled by a business that bring future benefit, while liabilities are amounts it owes to others.

0:52Owner’s equity is the owner’s interest in the business after liabilities are deducted from assets. Debit entries increase assets and expenses, and credit entries increase liabilities, owner’s equity and income. To correct an error, compare what was recorded with what should have been recorded. A journal entry is a dated record showing accounts to debit and credit, amounts and an explanatory narrative. Corrections are entered in the general journal before they are posted to the ledger.

1:17Leave any correct part of the original transaction alone. Every correction here is dated the thirty-first of May, Nora’s financial year end. Revenue is the income a business earns from its main activity, such as selling goods or providing services. The costs used up in running the business and earning revenue during a period are called expenses. Profit for the year is the amount by which revenue exceeds expenses over one financial year.

1:40So an expense correction can change profit, while a transfer between customer accounts cannot.

Errors that preserve trial balance agreement

1:46An error of omission occurs when a transaction is not recorded at all. Nora sold goods on credit to Ellis for nine hundred dollars, but neither entry was made. Trade receivables are amounts owed by credit customers who have not yet paid for goods or services. Both the amount Ellis owes and the revenue from the sale are missing. Debit Ellis’s account by nine hundred dollars because the amount this customer owes rises.

2:07The matching credit goes to sales because revenue grows by nine hundred dollars. No suspense entry is needed, because equal amounts were omitted from both sides. This correction increases trade receivables and the profit for the year. An error of commission records the correct amount on the correct side, but in the wrong account of the correct class. Nora sold goods on credit to Leila for twelve hundred dollars, but debited Arun’s account instead of Leila’s.

2:29The credit to sales was correct, so that account needs no correction. The amount owed must move from Arun to Leila. Debit Leila’s account with twelve hundred dollars because her recorded debt must rise, and credit Arun’s account because his must fall. Total trade receivables remain unchanged because the same amount moves between customers. Neither profit nor total owner’s equity changes. An error of principle records a transaction in the wrong class of account.

2:54Nora bought equipment through the bank for two thousand dollars but debited repairs. Non-current assets are resources owned for continuing use in the business, rather than resale. Equipment is a non-current asset, whereas repairs are an expense, so the wrong entry charged the equipment’s cost against this year’s profit. The correction debits equipment with two thousand dollars because the business owns this non-current asset. The credit to repairs removes two thousand dollars of expenditure wrongly treated as an expense.

3:21The original bank entry was correct and remains unchanged. No depreciation is due on the equipment in this example, so profit and non-current assets both rise by two thousand dollars. A book of prime entry is where a transaction is first recorded from its source document before it is posted to the ledger. An error of original entry occurs when the wrong amount is entered in a book of prime entry and used for both entries.

3:42Nora bought goods for resale on credit from Cedar Supplies for one thousand five hundred dollars. She recorded the purchase as one thousand and fifty dollars. One thousand five hundred dollars minus one thousand and fifty dollars leaves a shortfall of four hundred and fifty dollars. Purchases records the cost of goods bought for resale, and that cost is understated, so debit purchases with the shortfall. Trade payables are amounts owed to suppliers for goods or services bought on credit.

4:05Credit Cedar Supplies with four hundred and fifty dollars, because the amount owed to this supplier rises. Nora’s closing inventory of unsold goods is unchanged, so the correction reduces profit and increases trade payables. An error of complete reversal uses the correct accounts and amount, but reverses the debit and credit entries. Nora paid rent of eleven hundred dollars, but debited bank and credited rent. The bank balance is therefore overstated, while the rent expense is understated.

4:31Each account needs the wrong entry cancelled and the correct entry made. Eleven hundred dollars plus eleven hundred dollars gives twenty-two hundred dollars. Rent is debited with twenty-two hundred dollars, which cancels the wrong credit and records the expense. The matching credit of twenty-two hundred dollars to bank reduces the recorded money at bank. Both profit and the bank balance fall by twenty-two hundred dollars. Compensating errors are two or more mistakes whose effects on the trial balance cancel each other out.

4:57Nora understated wages by two hundred and fifty dollars and overstated advertising by the same amount. One debit balance is too small, while another is too large. The matching totals hide two incorrect expense balances. The correction debits wages with two hundred and fifty dollars because the wages cost must rise, and credits advertising because that expense must fall. Total expenses are unchanged, so there is no overall profit adjustment.

5:21The individual accounts are still corrected, although the statement totals stay the same.

Suspense account corrections

5:26A suspense account is a temporary account used to record the difference between trial balance totals until the errors are found. Nora’s debit total is twenty-four thousand dollars, while her credit total is twenty-four thousand four hundred and seventy dollars. Twenty-four thousand four hundred and seventy minus twenty-four thousand leaves a difference of four hundred and seventy dollars. The debit total is smaller, so the suspense balance of four hundred and seventy dollars is a debit.

5:48Twenty-four thousand dollars plus four hundred and seventy dollars equals twenty-four thousand four hundred and seventy dollars. The debit and credit totals now agree at twenty-four thousand four hundred and seventy dollars. This agreement is only a temporary measure, not proof that the records are correct. Nora must now find the errors that caused the difference. A single-sided entry occurs when only one part of the double entry is recorded.

6:11Nora credited bank for a rent payment of three hundred dollars but omitted the debit to rent. The bank account already shows the payment correctly. Only the missing rent debit needs to be added. Rent is debited with three hundred dollars because the recorded expense is understated. The other side of the correction is a credit to suspense, because this error left recorded debits three hundred dollars short. Profit and owner’s equity both fall by three hundred dollars.

6:34Bank remains unchanged because its original credit was correct. An entry on the same side twice occurs when both parts of a transaction are recorded as debits, or both as credits. Priya, a credit customer, paid four hundred dollars by bank transfer. Nora debited both the bank account and the customer’s account. The bank debit correctly records the money received. The customer’s account needed a credit instead, so the wrong debit must be cancelled and the missing credit supplied.

6:59Four hundred dollars plus four hundred dollars equals eight hundred dollars. Priya’s account is credited with eight hundred dollars because recorded trade receivables must fall. The matching debit goes to suspense, because this error made recorded debits eight hundred dollars too large. Profit is unchanged because neither revenue nor an expense needs correction. A casting error is an incorrect addition of a column of figures. The purchases journal records credit purchases of goods from invoices received.

7:24Nora’s purchases journal total was understated by seven hundred dollars, and that wrong total was posted to purchases. The individual credits to suppliers were correct, so only purchases needs an extra debit. The correction debits purchases with seven hundred dollars because the recorded cost of goods bought for resale must rise. Suspense takes the matching credit, because the wrong total left recorded debits seven hundred dollars short. With closing inventory unchanged, profit and owner’s equity fall by seven hundred dollars.

7:51Trade payables need no adjustment because the supplier entries were correct. A transposition error occurs when digits are recorded in the wrong order. Nora sold goods on credit to Mila for six hundred and thirty dollars and credited sales correctly. However, Mila’s account was debited with only three hundred and sixty dollars. Six hundred and thirty dollars minus three hundred and sixty dollars equals two hundred and seventy dollars. Only the customer’s account is wrong, not revenue.

8:15Debit Mila’s account with two hundred and seventy dollars because her recorded debt must rise. The credit of two hundred and seventy dollars goes to suspense, because the transposed figure left recorded debits that much short. Total trade receivables rise by two hundred and seventy dollars. Profit stays unchanged because the sales credit was already correct.

Closing the suspense account

8:33Each entry in the suspense account names the other account in the correction. The debit side adds up to twelve hundred and seventy dollars, from four hundred and seventy plus eight hundred. On the credit side, three hundred plus seven hundred plus two hundred and seventy also equals twelve hundred and seventy dollars. The account closes with a nil balance, so nothing is carried down. A nil suspense balance shows that the corrections have removed the whole trial balance difference.

8:56Errors of omission and commission can still exist, because they do not create a difference. Suspense is used only when a correction repairs unequal debits and credits. An equal two-sided error is corrected directly between the affected accounts. We can now adjust Nora’s draft profit for the year of ten thousand dollars for every correction. Missing revenue increases profit, whereas understated expenses reduce it. Moving the equipment cost out of repairs raises profit, because that cost belongs in an asset account.

Calculating corrected profit

9:24Capital items do not affect profit, except through depreciation. Add nine hundred dollars for the omitted sale to reach ten thousand nine hundred dollars. Removing two thousand dollars from repairs raises the running profit to twelve thousand nine hundred dollars. The understated credit purchase is a deduction of four hundred and fifty dollars. That leaves a subtotal of twelve thousand four hundred and fifty dollars. Deduct twenty-two hundred dollars for the reversed rent payment to reach ten thousand two hundred and fifty dollars.

9:51The missing rent debit reduces this by three hundred dollars to nine thousand nine hundred and fifty dollars. Finally, the purchases casting error takes away seven hundred dollars. Corrected profit for the year is nine thousand two hundred and fifty dollars. The transfer between customers, the correction for Priya and the transposition correction do not affect profit. Wages and advertising have equal and opposite effects, so their combined adjustment is zero.

10:13Ten thousand dollars minus nine thousand two hundred and fifty dollars shows a fall in profit of seven hundred and fifty dollars. Owner’s equity drops by the same amount, because profit for the year belongs to the owner.

Statement of financial position and exam technique

10:24A statement of financial position shows assets, liabilities and owner’s equity at a particular date. Ellis’s nine hundred plus Mila’s two hundred and seventy, minus Priya’s eight hundred, raises trade receivables by three hundred and seventy dollars. Equipment rises by two thousand dollars, while bank falls by twenty-two hundred dollars. The transfer from Arun to Leila leaves total trade receivables unchanged. Suppose draft assets total thirty thousand dollars, including the suspense debit of four hundred and seventy dollars.

10:52That suspense balance is not a real asset. Adding equipment gives thirty-two thousand dollars, and deducting the bank correction leaves twenty-nine thousand eight hundred dollars. The receivables adjustment raises this to thirty thousand one hundred and seventy dollars. Removing the suspense balance leaves corrected assets of twenty-nine thousand seven hundred dollars. Liabilities rise by the four hundred and fifty dollars owed to Cedar Supplies. That takes them from eight thousand dollars to eight thousand four hundred and fifty dollars.

11:17Owner’s equity falls by seven hundred and fifty dollars, from twenty-two thousand dollars to twenty-one thousand two hundred and fifty dollars. The draft total of thirty thousand dollars therefore drops by three hundred dollars to twenty-nine thousand seven hundred dollars. So assets of twenty-nine thousand seven hundred dollars equal eight thousand four hundred and fifty plus twenty-one thousand two hundred and fifty dollars. Paper One has forty multiple-choice questions, while Paper Two has five compulsory structured questions.

11:44Prepare means present information in a suitable format, so a journal answer needs dates, account names, amounts and narratives. Marks for a corrected profit come from showing each addition and deduction, since calculate means work out from given figures. Explain means give reasons, why and how, supported by evidence. Consider an exam question asking you to explain why the correction for Priya leaves profit unchanged. The bank debit was correct, so the money received needs no further entry.

12:11The correction reduces trade receivables and clears part of the suspense balance. Neither revenue nor expenses change, and only those items alter the profit for the year, so that link earns the mark. Examiners often see answers that repeat an entry which was already right, so adjust only the difference between the existing and required records. A complete reversal needs twice the original amount, because the wrong entry must be cancelled before the correct one is made.

12:34Put the opening suspense balance on the side with the smaller trial balance total. Adjust profit only where income or expenses change. Journal corrections restore the accounts that should contain each transaction’s effects. Suspense temporarily fills an unequal trial balance and clears when the responsible errors are corrected. Profit adjustments follow changes to income and expenses, while asset and liability corrections flow into the statement of financial position. Matching totals and correct account balances are separate checks, and both are necessary.