Financial Accounting - Rectification of Errors

Financial accounting deals with recording and maintaining every monetary transaction of an organization. However, sometimes, a few entries might be either incorrect or used at the wrong place. In financial accounting, the process of correcting such mistakes is known as Rectification of Errors.

Types of Errors

Two most common types of errors, which are usually occurred at the time of preparation of Financial Statements are discussed below.

Error which Effect only One Account

• Omission of posting of balance in a Trial Balance.
• Error of carried forward of balance.
• Error of casting and posting.

Error which Effect Two or more Accounts

The nature of errors, which occur during the preparation of Financial Statements are −

• Error of posting in wrong account.
• Error of principle.
• Error of omission.

Methods of Rectification of Errors

There are three types of methods used in rectification of Errors −

Replacing Correct Figure by Striking Off the Wrong Figure

For example, cash payment of Rs. 989 on the account of stationery purchased written as Rs. 998, will be corrected as −

Cash Book

Through Journal Entry

Normally, there are three types of errors, which can be rectified by passing Journal Entries −

·        Short credited or debit in one account and excess debit or credit in another account. For example, purchase of stationery for Rs. 989 wrongly debited to purchase of raw material account will be corrected as follows −

Journal Entry

·        If, by mistake one account is debited as well as credited with wrong amount simultaneously. For example, Cash purchase of stationery of Rs. 989 booked with an amount of Rs. 489 will be corrected as follows −

Journal Entry

·        If there is an omission of recording a transaction, it can be rectified by passing journal entry to book that omitted transaction. For example, omission of recording transaction of purchase of raw material for Rs. 5000 from Mr. X will be recorded and corrected by passing the following journal Entry −

Journal Entry

If there is a Mistake that Effects Trial Balance

·        Before closing the books and transferring the difference in suspense account and

·        After the agreed difference is transferred into the suspense account, following accounting treatment will be done −

o   Earlier entry debited or credited with fewer amount will be rectified by repeating that entry with difference amount to complete that amount. For example, entry done with Rs. 500 instead of Rs. 5000 will be rectified by doing same entry with an amount of Rs. 4500. In case, where entry wrongly debited or credited to other account may be rectified by doing reversal of old entry to nullify earlier effect.

If expense booked with less amount entry then −

If income is booked with less amount, it will be rectified as −

If posting done in wrong account that will be rectified as follows −

In case (ii) where difference has already been transferred to suspense account, further amount will be debited or credited to respective account and correspondingly suspense account will be debited or credited. Thus, these entries would reduce/nil the balance of suspense account.

Effect of Errors on Agreement of Trial Balance

The errors by which there is no change on both side of trial balance or wrong effect on trial balance with same amount will not lead to effect on agreement of Trial Balance. Errors of omission, error of posting with wrong amount on both side, or Error of principles are the example of such errors. To find out such errors is a challenging job for any book keeper or an accountant.

Effects of Errors on Financial Statements

Effect of error depends on the nature of effected accounts. If errors relate to nominal account, it will either increase or reduce the profit and rectification will reduce excess profit or Loss. Effect of error on Trading and Profit account ultimately effect the Balance-Sheet of a company too, because reduced profit or excess profit ultimately transferred to capital account, which is a part of the Balance Sheet.

There are some errors, which effect Trading or Profit and Loss account and Balance sheet simultaneously, like entry of depreciation will affect profit as well as value of the Fixed Assets.

Some entry may effect on Balance sheet only like, for instance omission of entry of cash paid to purchase fixed assets will affect Balance Sheet of a firm only.

Rectification of Errors after Preparation of Final Accounts

To remain unaffected Profit or Loss of the current financial year, the errors, which took place in last financial years are adjusted and rotated through a Profit & Loss adjustment account. Balance of this account directly transferred to capital account of firm without affecting the current year profit or loss.