Trial balances and correcting errors

1 Introduction

This chapter gives a brief revision of extracting trial balances and then investigates the errors that could have occurred in a bookkeeping system.

2 Recording transactions and the trial balance

The double entry system consists of:

• The cash account: this records amounts paid into and out of the bank account
  

• The petty cash book: this records small amounts of cash paid for day to day expenses, such as buying postage stamps and teas or coffee for the office.
  

• The general or nominal ledger, which records amounts such as wages, sales, purchases, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets.
  

In addition there are two detailed memorandum ledgers

• The payables ledger, in which the details of exactly what is owed to whom are recorded. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.
  

• The receivables ledger, in which the details of exactly what is owed by whom are recorded. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.
  

IF double entry had been carried out correctly then the value of all debits should equal the value of all credits made and when balances on each account are worked out, the sum of the debit balances should equal the sum of the credit balances. The document showing this is the trial balance. For example:

Trial balances should be taken out regularly (at least monthly) to see if something has gone wrong with the maintenance of double entry. It is much easier finding an error in one month’s postings than a whole year’s.

However, trial balances will not detect all errors: they only detect errors where the debit does not equal the credit entry, or where the trial balance has been taken out incorrectly.

Errors not found by trial balance can be categorised as:

• Errors of commission
  

Example: an expense of rent was incorrectly debited to the wages account.

• Errors of omission
  

Example: an invoice from a supplier for $100 is not entered into the purchases or payables at all, so no entry is made for that transaction.

• Compensating errors
  

Example: rent paid of $210 is debited to the rent account as $120 (error = $90 too little debited) and cash sales of $540 are credited to the sales account as $450 (error = $90 too little credited).

• Errors of principle
  

Example: the expense of rent of $350 was incorrectly posted to a receivables account. This error is worse than the error of commission above because it will affect the profit of the business. Instead of adding to an expense, the value of an asset has increased.

A common cause of errors, rather than a type of error, is a transposition error, such as writing 1234 instead of 1324. A way to try to see if transposition might have been a cause of an error is to see if the error is evenly divisible by 9. For example 1324 – 1234 = 90 which can obviously be divided by nine without a remainder. A transposition error could therefore have been the cause of the error.

None of the types of error described above will cause the trial balance not to balance. The errors once found are easy to correct by journal.

If a trial balance does not balance then:

1. A one sided error must have occurred (Such as Credit cash $120, Debit Purchases $100 and forgetting about the sales tax of $20).
   

2. The production of the trial balance is incorrect. For example, leaving out an account or listing it on the wrong side of the trial balance.
   

Non-balancing trial balances often use a suspense account to indicate the amount by which the two sides differ, and as errors are found, the suspense account can be brought back to zero, indicating that the two columns of the trial balance agree.

For example: if the trial balance produced was this:

Then a suspense account would be introduced to make it balance:

This suspense account indicates that there was originally more on the credit side than on the debit side so that more debits are needed.

An investigation of the differences then needs to be carried out. Let’s say that the following errors were found:

1. Rent of $400 had been charged to wages.
   

2. Cash received of $200 had been assumed to be from a customer paying an invoice in the receivables ledger. In fact it was a new sale.
   

3. Petty cash of $44 has been left out of the trial balance
   

4. A sales figure of $820 had been debited to receivables (customers) as $280, though had been correctly posted to the sales account.
   

5. Discounts allowed to customer of $30 had been credited to the sales account rather than debited to the discounts allowed account.
   

Now look at each error and decide how to correct it. Also think carefully if it would have caused the trial balance not to balance: if so, the suspense account will be affected.

The trial balance with the adjustments so far will be as follows:

The remaining errors are all of a one-sided nature, and as they are corrected the suspense account can be updated. The suspense account is a real account in the general ledger: it holds the difference until the errors are found, and each correction is posted to it by journal until its balance is nil.

It is easy to make the wrong adjustments in the suspense account. The key is to think:

1. How are the accounts or trial balance to be corrected? What side is to be adjusted and by how much?
   

2. Having worked that out, the suspense account entry is always on the other side.
   

Continuing with the example;

Error 3

$44 has been left out of the trial balance. $44 needs to be introduced on the debit side of the trial balance so the suspense account will be credited $44.

Error 4

Receivables were debited by $280 when they should have been debited by $820. The size of the error is therefore $540 and this needs to be an extra debit to receivables. Therefore, credit the suspense account by $540.

Error 5

$30 had been credited to sales rather than debited to discounts allowed. The size of the error is $30 x 2 = $60. $30 has to be debited to the sales account (ie taken out of it) and $30 debited to the discounts allowed account.

The suspense account would therefore be:

Those three corrections are made in the ledger by journal, and the suspense account is the other side of every one of them:

The $644 credited by those journals exactly clears the $644 debit the suspense account was opened with, so the suspense account is now nil and can be closed. That is the test: if the suspense account will not clear to nil, an error has not been found yet.

The trial balance would be:

3 FA1 exam focus — Chapter 7