3.2 Correction of errors

                           

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Errors revealed by the Trial Balance

Errors which cause the Trial Balance to fail to balance are errors which affect only one account involved in the double entry 

We need to make use of an extra ledger account called a Suspense Account in order to correct these types of errors

When you cannot get the Trial Balance totals to agree:

place a 'Title Suspense Account' in the Trial Balance and enter the amount in whichever column makes the totals agree

 Next step is to open a Suspense Account ledger and enter the amount on the side suspense account appeared in the trial balance for that amount.

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Understanding the Effects of Correcting Errors

Impact on Profit in the statement of profit or loss (Income Statement):

Errors Affecting Revenue or Expenses: Correcting these errors will directly impact the profit. For example, if an expense was understated, correcting it will decrease the profit, whereas if revenue was understated, correcting it will increase the profit.

Examples from above practice question would help you understand the relation:

Understated Expense: If Rent and Rates expense of $760 was not recorded, correcting this will decrease the profit by $760.

Overstated Expense: If wages expense of $630 was recorded extra, correcting this will increase the profit by $ 630.

Understated Revenue: If sales revenue of $500 was not recorded, correcting this will increase the profit by $500.

Impact on the Statement of Financial Position (Balance Sheet):

Assets and Liabilities: Errors can lead to incorrect asset and liability balances. Correcting these errors ensures that the statement of financial position accurately reflects the business's financial status.

Examples from above practice question would help you understand the relation:

Understated Assets: If Motor Vehicle was understated by $1945, correcting this will increase the assets by $1945.

Overstated Liabilities: If a loan repayment was recorded twice, reducing liabilities incorrectly by $1,000, correcting this will increase liabilities by $1,000.

Link Between Profit and the Statement of Financial Position:

Profit and Retained Earnings: The profit or loss for the period affects the retained earnings in the statement of financial position. A higher profit increases retained earnings, while a lower profit decreases it.

Adjusted Financial Statements: After correcting errors, both the statement of profit or loss and the statement of financial position must be adjusted to reflect the true financial status.

Example Question from Past Papers

Question: A business discovered the following errors after preparing its financial statements:

Sales of $500 were not recorded.

An expense of $300 was recorded twice.

Explain the effects of these errors on the profit and the statement of financial position.

Possible Answer:

Effect on Profit:

Sales Not Recorded: Adding $500 to sales will increase the profit by $500.

Expense Recorded Twice: Removing the duplicated $300 expense will increase the profit by $300.

Overall Effect on Profit: Profit will increase by $800 ($500 + $300).

Effect on the Statement of Financial Position:

Assets: Trade receivables will increase by $500 due to the unrecorded sales.

Liabilities: No change in liabilities directly due to the correction of the expense error, but the retained earnings will increase by $800 due to the higher profit.

Overall Effect on Financial Position: Assets increase by $500, and retained earnings increase by $800.

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