The process of recording financial transactions of the business is known as accounting. Every business must prepare to maintain its proper accounts irrespective of its size and legal form. In the case of smaller companies, accounts are prepared by the bookkeeper or an accountant, whereas dozens of employees prepare the accounts in larger companies. It is extremely important to prepare correct accounts of the business since it helps give a true and clear view of the position of the business, helps in tax season, and so on. Preparing the accounts also summarises the operations of the company and cash flows over the period of time.
However, sometimes unintentional mistakes are also seen in the accounting process, often called accounting errors. They need proper investigation and correction. The accounting errors can often lead to showing the wrong position of the business. In this article, we will learn more about types of errors in accounting with examples and how to prevent accounting errors.
Did You Know?
The words' debit' and 'credit' have originated from the Latin words 'debitum' and 'creditum'.
What Are Accounting Errors?
Accounting errors refer to the unintentional mistakes that occur in making accounts of the company. Whenever an accounting error is seen in the books of accounts, it must be fixed immediately, or an investigation must be conducted regarding that error if no immediate solution is there. Accounting errors are different from fraud. Fraud is an intentional act to alter or hide the correct information in accounting. Since the accounting errors are unintentional, it is easier to detect and fix them. For example, if the total debit and credit sides of the trial balance don't match, it is easy for the accountant to find an inaccurate account. Sometimes, there are no trial balance errors, and some other accounting errors exist. In that case, it becomes difficult to find out the errors in accounts. Some examples of accounting errors include recording of the same entry twice, the wrong amount recorded in the books of accounts, the correct amount recorded correctly but against a different account, wrong debit or credit of accounts, and so on, and so on.
Also Read: Know All About GAAP (Generally Accepted Accounting Principles)
Types of Accounting Errors
There are various types of errors in accounting, such as errors of original entry, errors of duplication, errors or omission, errors of entry reversal, errors of principle, errors of commission, and so on. But the most common accounting errors are the clerical errors or the errors in accounts principles. Various types of accounting errors with examples are –
The Error of Original Entry
Posting the wrong amount in an account is known as the error of original entry. The effect of posting the wrong amount will also be on the other account involved in the transaction. In short, all the accounts involved in the transaction will show the wrong balance. The most common example of the error of original entry is the transposition error. For example, the accountant has recorded ₹2,500 in place of ₹5,200. It will under-debit, under-credit, over-debit, or over-credit the relevant ledgers involved.
Error of Duplication
Passing the same journal entry twice for a single transaction or posting the same entry or amount in an account twice is known as an error of duplication. For example – the electricity expenses for the month had been debited twice.
Error of Omission
Not passing a journal entry in the books of accounts even after the occurrence of the transaction is known as an error of omission. It also includes not posting the journal entry in the relevant ledgers. For example – not crediting the accounts payable account when the goods are purchased on credit from them. For instance, it is very common if there are purchase transactions with a single supplier, and the invoice gets lost, or for some other reason, it is not recorded in the books.
The Error of Entry Reversal
The error of entry reversal means recording the journal entry oppositely, i.e., credit was recorded as a debit or vice versa. For example – purchases are recorded as credit instead of debit, and sales are recorded as debit instead of credit.
Error Of Accounting Principle
The error of the accounting principle means following the accounting principle in the wrong way. For example, the expenses for installing machinery are treated as the revenue expenditure. The correct treatment should be that installation expenses must be treated as capital expenditure, hence adding in the cost of machinery. The other example of an error in accounting principle can be posting the asset purchased as an operating expense. However, it should be recorded as the purchase of a fixed asset.
Error of Commission
This type of accounting error occurs when the accountant records the transaction in one correct account but to the wrong subsidiary account. For example, an asset purchased from the creditor has been properly debited to the asset account but to the wrong creditor account.
Compensating Errors
When one accounting error is compensated through another accounting error, it is known as compensating error. For example – the wrong amount recorded in the debtor ledger is compensated by the same wrong amount written in the creditor ledger.
How Can Accounting Errors Affect Your Business?
The accounting errors can be both minor and substantial. But they can have a serious impact on your business. The various impacts of accounting errors can be –
1. Wrong income reporting – Wrong recording of the business's expenses can result in higher operating profits and can result in over-reporting of income.
2. Incorrect cash flows – When the journal entries are posted incorrectly, it can report wrong cash flows in the form of overstated or understated cash.
3. Incorrect expense reporting – Failing to record the business expenses or recording the expenses lower than the actual can result in overpayment of taxes.
4. Late payment fees – When the misclassification expenses are discovered later on, some invoices had been past due till that time. It can result in payment of late fees and interest.
5. Detecting fraud – Various frauds can occur at any business, such as embezzlement by the cashier. When the accounting records are not matching, it can reveal something wrong, and
therefore investigation must be done.
Also Read: Accounting vs Bookkeeping
How to Prevent Accounting Errors?
Every business must check that its items and transactions are properly recorded and entered into the books of accounts. The business must be careful with its financial information. Various steps that you can take to prevent the accounting errors are –
1. Train your staff for data accuracy – The employees responsible for recording the business expenses must know the business' accounts and descriptions. You must explain this system to your employees taking the help of certain software. It would help if you also introduced the policies of the company's documentation. You must also hire someone knowledgeable who can clear the doubts of your employees.
2. Don't overload your employees – The overloaded employees with work can commit more accounting errors than those who have adequate time to do the work and revise it. You can use expense report software to import them into your accounting systems easily.
3. Check the difference between budgeted and actual expenses – You should use the accounting system to be on the right financial track. Your budget can show your estimated amount for a particular activity not present in the actual expenses. You can also calculate the miscalculated errors by comparing the actual expenses with the budgeted expenses.
4. Implement internal controls – You must put internal controls in your business to help you detect or avoid accounting errors. You can conduct the bank reconciliation at regular intervals to detect accounting errors. You can also review the credit card statements to ensure that the amount is entered correctly in the books of accounts.
Conclusion
Preparing the proper books of accounts is very important for a business. It helps to reveal the true failure and success of the company. It can also help a business prepare its finances and create a budget for its operations accordingly. But, the accounting errors in the books can negatively impact the business since they can affect its goodwill. It can put the business in trouble due to the taxation system also. You must always follow the correct accounting principles and standards to prevent accounting errors. We hope that this article has made you understand the different types of accounting errors and the ways to prevent accounting errors.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.
