INCOME TAX

 

INTERNATIONAL BUSINESS

FINANCIAL ACCOUNTING - I

 RECTIFICATION OF ERROR  - UNIT II

The errors may be detected:

1.     Before preparation of the trial balance;

2.     After preparation of the trial balance but before preparation of final accounts; and

3.     After preparation of final accounts.

The rectification of the errors will be guided by

·         the nature and effect of the errors and

·         the point of time at which the errors have been detected.

A. ON THE BASIS OF NATURE

1. ERROR OF OMISSION:

It results from a complete or partial omission of recording a transaction.

For example, a transaction may be recorded in the subsidiary book but omitted to be posted to any of the ledger accounts.  This is a case of partial omission.

However, if a transaction is totally omitted to be entered in the books then it is a case of complete omission.

A complete omission will not affect the agreement of the trial balance but a partial omission will affect the agreement of a trial balance.

2. ERROR OF COMMISSION:

It results from an act of commission i.e. entries wrongly made in the journal or ledger.  It may be an

·         error of posting,

·         error of casting,

·         entering wrong amounts,

·         entering a transaction in a wrong subsidiary book etc.  

Unless the effects of errors of commission counterbalance each other, the agreement of the trial balance becomes affected.

3. ERROR OF PRINCIPLE:

          It Is an error occurring due to wrong application of basic Accounting Principles.  The main reason behind such an error is incorrect classification of capital and revenue items.

For example,  purchase of an Asset may be recorded through the Purchase day book instead of debiting the Asset account.  Or wages paid for the installation of an asset may be debited to the wages account  instead of debiting the asset account with the amount of wages.

An error of principle will not affect the agreement of a trial balance. However, it will result in misrepresentation of the state of affairs and operational results of a business.

4. COMPENSATING ERRORS:

If the effect of an error is counterbalanced or cancelled out by the effect of another error or errors  then such errors are known as compensating errors.  Since the compensating errors as a whole cancel out the effect of each other,  the agreement of trial balance is not affected. Thus it becomes difficult to detect such errors.

B. ON THE BASIS OF EFFECTS:

1. ONE SIDED ERRORS:

One sided error is an error whose effect falls on only one account.  It may arise due to

·         Wrong casting of any day book;

·         Posting made to the Wrong side of the relevant account;

·         Duplicate posting of the same amount  in an account.

One Sided errors cause a disagreement of the trial balance and hence are easy to detect.

2.  TWO SIDED ERRORS:

A Two sided error maybe

·         Affecting two accounts at the same direction and not affecting the agreement of the trial balance.  For example Mr A’s account credited instead of Mr B account for an amount received from Mr B.

·         Affecting two accounts at opposite direction and affecting the agreement of the trial balance.  For example, Mr A’s account debited instead of Mr B account being credited for an amount received from Mr B.

3. MORE THAN TWO SIDED ERRORS:

An error which affects more than two accounts simultaneously falls in this category.  This may or may not affect the agreement of a trial balance depending on the situation in each case.

EFFECTS OF ERRORS ON TRIAL BALANCE

Depending on its effect on the trial balance,  the errors  may be divided into two categories-

1.     Errors affecting the agreement of trial balance;  and

2.     Errors not affecting the agreement of trial balance.

Errors affecting the agreement of Trial Balance (TB will not agree)	Errors not affecting the agreement of Trial Balance (TB will agree)
1. An error of Partial Omission	1. An error of complete omission
2. An error of commission whose effect is not cancelled out by a compensating error	2. Compensating Errors
3. Error in balancing an account or casting a subsidiary book	3. Error of Principles
4. An error of wrong posting unless the correct amount is posted to the right side of a wrong account.	4. An error of wrong posting of the correct amount to the right side of a wrong account.

 ONE SIDED ERRORS

EXAMPLE 1

Cash paid to Ram Rs 1000, debited to Ram Account as Rs 100

Note: We have to assume that Cash Account has been correctly credited

Solution:

Point of  Detection		Guideline for Rectification		Remarks
Before Trial  Balance		Rectify Ram Account directly in the Ledger by posting shortfall  of Rs (1000-100) = 900 in the  debit side		Only Ram Account was  underdebited by Rs 900
After Trial  Balance but  before Final  Accounts		Pass the rectification entry: Ram Account……. Dr Rs 900 To Suspense Account Rs 900		Since it is a one sided error,  the Trial Balance will not agree.  Thus the excess credit of Rs  900 must have been made  good by introduction of  Suspense A/c with a debit  balance of Rs 900. Now by rectification, the  suspense account is being  abolished.
After Final  Accounts		Same as above i.e pass the  rectification entry: Ram Account……. Dr Rs 900 To Suspense Account Rs 900		If the account involved with  one sided error is a nominal  account then we will use the  P&L Adjustment Account. For example, if salary account  was involved instead of Ram  account then the rectification  entry would have been: P&L Adj Account..Dr Rs 900 To Suspense Account Rs 900

GUIDELINES FOR RECTIFICATION OF TWO SIDED ERRORS AFFECTING TWO ACCOUNTS IN THE SAME DIRECTION

EXAMPLE 2

Cash paid to Ram Rs 1000, wrongly debited to Shyam Account

Note: We have to assume that Cash Account has been correctly credited

Solution:

Point of  Detection		Guideline for  Rectification		Remarks
Before Trial  Balance		The correct account is to be  debited & the wrong account  is to be credited by the  following entry: Ram Account Dr Rs 1000 To Shyam Account Rs 1000		One account debited in place of another account
After Trial  Balance but  before  Final Accounts		Same as above		Please note that the Suspense Account was not used here as the  agreement of the Trial Balance was not affected.
After Final  Accounts		Same as above BUT------->		If the rectification involves one Nominal Account, use P&L Adj Account.  However, If both the accounts are nominal accounts then no entry is required.

GUIDELINES FOR RECTIFICATION OF TWO SIDED ERRORS AFFECTING TWO ACCOUNTS IN THE OPPOSITE DIRECTION

EXAMPLE 3

Cash paid to Ram Rs 1000, wrongly credited to Shyam Account

Note: We have to assume that Cash Account has been correctly credited

Solution:

Point of  Detection		Guideline for  Rectification		Remarks
Before Trial  Balance		Make the corrections directly in the ledger accounts of Ram and Shyam. Eg. In Ram A/c "To Error Rectified 1000" In Shyam A/c "To Error Rectified 1000"		The effects are in the  opposite direction so the  rectification cannot be  done with a journal entry.
After Trial  Balance but  before  Final Accounts		Rectify by passing the  following entry: Ram A/c Dr Rs 1000 Shyam A/c Dr Rs 1000 To Suspense A/c Rs 2000		Credit instead of a debit resulted into Suspense Account with double  amount in the Trial Balance. This Suspense A/c is now being set off with the  rectification entry.
After Final  Accounts		Same as above BUT------->		If the rectification involves Nominal Account, use P&L Adj Account.

GUIDELINES FOR RECTIFICATION OF TWO SIDED ERRORS AFFECTING TWO ACCOUNTS WITH UNEQUAL AMOUNTS

EXAMPLE 4

Cash paid to Ram Rs 1000, wrongly debited to Shyam Account as Rs 100

Note: We have to assume that Cash Account has been correctly credited

Solution:

Point of  Detection		Guideline for  Rectification		Remarks
Before Trial  Balance		Make the corrections directly in the ledger accounts of Ram and Shyam. Eg. In Ram A/c "To Error Rectified 1000" In Shyam A/c "By Error Rectified 100"		The amounts involved are unequal so the  rectification cannot be  done with a journal entry.
After Trial  Balance but  before  Final Accounts		Rectify by passing the  following entry: Ram A/c Dr Rs 1000 To Shyam A/c Rs 100 To Suspense A/c Rs 900		Shortage in Debit column of Trial Balance of Rs 900 resulted into Suspense Account with same amount. This Suspense A/c is now being set off with the  rectification entry.
After Final  Accounts		Same as above BUT------->		If the rectification involves Nominal Account, use P&L Adj Account.

ILLUSTRATION ON RECTIFICATION OF ERRORS

The following errors have been located from the books of Mr Bajaj:
1. Cash paid to Jeet Rs. 950 has been posted to the debit of his account as Rs. 590.
2. Purchase day book was undercast by Rs. 1000
3. Sales day book was overcast by Rs. 300
4. Wages paid Rupees 600 for the installation of a new machine has been debited to wages account.
5. Interest paid Rupees 59 has been credited to interest received account.
6. Goods sold to Mr Tom for Rupees 500 has been recorded through the Purchase Day Book.

Indicate, with reasons, the accounts which have been affected due to each of the above errors and rectify the errors if those are detected:
(a) Before preparation of the Trial Balance
(b) After preparation of Trial Balance but before preparation of Final Accounts
(c) After preparation of the Final Accounts.

Solution:

1. CASH PAID TO JEET RS. 950 HAS BEEN POSTED TO THE DEBIT OF HIS ACCOUNT AS RS. 590.

Accounts Effected: Jeet Account

Reason: The entry in the cash book is correct but Jeet Account is debited by Rupees 590 in place of Rupees 950. It is under debited by 950 – 590 = 360. It is a one sided error.

Rectification Before Trial Balance

Jeet Account is to be debited by Rs 360 directly in the ledger. Write “To Error rectified Rs 360” in the debit side of Jeet Account.

Rectification After Trial Balance but Before Final Accounts

Pass the journal entry:

Jeet Account Debit     Rs 360

To Suspense Account   Rs 360

Rectification After Final Accounts

Pass the journal entry:

Jeet Account Debit     Rs 360

To Suspense Account   Rs 360

2. PURCHASE DAY BOOK WAS UNDERCAST BY RS. 1000

Accounts Effected: Purchase Account

Reasons: The total from the Purchase day book, on daily or weekly basis, is posted to the debit of Purchase Account in the ledger. On the other hand, each transaction of purchase recorded in the Purchase day book is separately posted to the credit of the relevant supplier or creditors account. As a result, the undercasting of the Purchase day book will only affect the debit side of the Purchase account. It will not affect the suppliers or creditors accounts.

Rectification Before Trial Balance

Purchase Account to be debited with Rs. 1000 directly

Rectification After Trial Balance but Before Final Accounts

Pass the journal entry:

Purchase Account  Debit   Rs 1000

To Suspense Account    Rs 1000

Rectification After Final Accounts

Pass the journal entry:

P&L Adjustment Account*  Debit   Rs 1000

To Suspense Account    Rs 1000

*Since Purchase Account is a Nominal account, the total debit balance of the Purchase account will be transferred to the Profit and Loss Account during preparation of the Final Accounts. Thus for making the rectification after preparation of the Final Accounts, the Profit and Loss Adjustment Account is required to be debited.

3. SALES DAY BOOK WAS OVERCAST BY RS. 300

Accounts Effected: Sales Account

Reasons: Same as above in point 2

Rectification Before Trial Balance

Sales Account to be debited with Rs. 300 directly

Rectification After Trial Balance but Before Final Accounts

Pass the journal entry:

Sales Account  Debit   Rs 300

To Suspense Account    Rs 300

Rectification After Final Accounts

Pass the journal entry:

P&L Adjustment Account*  Debit   Rs 300

To Suspense Account    Rs 300

*Same justification as in point 2 above.

4. WAGES PAID RUPEES 600 FOR THE INSTALLATION OF A NEW MACHINE HAS BEEN DEBITED TO WAGES ACCOUNT.

Accounts Affected: Wages Account and Machine Account

Reasons: It is an error of principle. And since this error affects two accounts, it is a two sided error. Wages paid for installation of Machine is a Capital expenditure for which the Machine Account should have been debited. But wrongly the Wages Account has been debited. Since the error is in the same direction (i.e the wrong account has been debited instead of the correct account being debited) the agreement of Trial Balance will not be affected. We will have to assume that the Cash Book is correct.

Rectification Before Trial Balance

Pass the journal entry:

Machine Account Debit     Rs 600

To Wages Account          Rs 600

Rectification after Trial Balance but Before Final Accounts

Pass the journal entry:

Machine Account Debit     Rs 600

To Wages Account          Rs 600

Rectification after Final Accounts

Pass the journal entry:

Machine Account Debit     Rs 600

To P&L Adjustment* Account Rs 600

* Since Wages Account is a nominal account.

5. INTEREST PAID RUPEES 59 HAS BEEN CREDITED TO INTEREST RECEIVED ACCOUNT.

Accounts Affected: Interest Paid Account & Interest Received Account

Reasons: Interest has been paid which is an expense. The Interest Paid Account should have been debited for the same. However the Interest Received Account has been credited wrongly. This is a two sided error in the opposite direction. The agreement of the Trial Balance will be affected by double the amount of the error.

Rectification Before Trial Balance

Debit the Interest Paid Account by Rs 59 directly in the ledger. Also Debit the Interest Received Account by Rs 59 in the ledger for nullifying the effect of the error made.

Rectification After Trial Balance but before Final Accounts

Pass the entry:

Interest Paid Account Debit   Rs 59

       Interest Received Account Debit  Rs 59

To Suspense Account Rs 118

Rectification After Final Accounts

Pass the entry:

P&L Adjustment* Account Debit    Rs 118

To Suspense Account   Rs 118

* Interest Paid and Interest Received are both Nominal Accounts

6. GOODS SOLD TO MR TOM FOR RUPEES 500 HAS BEEN RECORDED THROUGH THE PURCHASE DAY BOOK.

Accounts Affected: Sales Account, Purchase Account & Tom Account

Points to be noted: The correct entry should have been:

Tom Account Debit    Rs 500

To Sales Account       Rs 500

However, the entry passed (wrong entry) is:

Purchase Account Debit   Rs 500

      To Tom Account          Rs 500

Trial Balance will agree as a set of double entry has been totally missed. Another set has been wrongly but totally introduced.

Rectification before Trial Balance:

Pass the entry:

Tom Account Debit   Rs 1000

To Purchase Account  Rs 500

To Sales Account       Rs 500

Rectification after Trial Balance but before Final Accounts:

Rectification after Final Accounts:

Pass the entry:

Tom Account Debit   Rs 1000

           To P&L Adjustment* Account  Rs 1000

* As the Purchase and Sales  Accounts are nominal accounts.