Accounting for Rectification of Errors: Classification, Suspense

Accounting for Rectification of Errors, To err is human! So, it is obvious that while we are doing the accounting of an entity, we can make mistakes. But more important is to analyze and correct the mistakes. So here, we are providing the basics of Accounting for Rectification of Errors. Here, we will have a look at how to rectify the errors if they are found in the same financial year or later on.

Accounting for Rectification of Errors

Basic features of correct accounting:

• All transactions and events must be recorded/ entered.
• Transactions and events must be recorded by a double-entry system and by following proper accounting Principles.
• All entries must be fully and correctly posted to ledger accounts.
• There must be arithmetical accuracy:
  • in Recording i.e. passing entry,
  • in Posting figures in accounts,
  • in totaling and balancing books of Entry and
  • in totaling and balancing of ledger accounts.

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ERROR

Meaning of an Error

If in books of account, any one or more of the above-mentioned basic elements/features of correct accounting are not followed, then we will say an error/mistake has been committed.

Classification of Errors:

1. Errors of Principle:

• That means there is an error in applying some accounting Principles,
• Such errors will not affect the agreement of trial balance i.e. these are double-sided error.

Ex. Treating a revenue expense as capital expenditure or vice versa or the recording of sale of a fixed asset as an ordinary sale. Must Check Cash Basis Vs Accrual Basis of Accounting.

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2. Clerical Errors:

• These are the errors committed in applying the accounting procedure.
• Such errors may or may not affect the agreement of trial balance.

Rectification in the same year can be:

• Before preparation of Trial Balance i.e. without opening a Suspense a/c or
• After preparation of Trial Balance i.e. after opening a Suspense a/c.

Suspense Account:

• When the trial balance does not tally, the difference is put into an account named Suspense a/c. Difference is:
  • debited to suspense a/c (if the debit side of the trial balance is short) or
  • credited to suspense a/c (if the credit side of the trial balance is short)
• Thus with the help of suspense a/c trial balance is artificially tallied.

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Rectification In Subsequent Years Books

Rectification in the next year:

• If errors are located after finalizing the accounts then it should be rectified in the next year’s accounts.
• The difference of Trial balance will also get transferred to next year’s books under the name Suspense a/c.
• This will involve the preparation of a Profit and Loss Adjustment account. Must Read Steps to Locate Errors.

Profit and Loss Adjustment Account:

• The rectification entry will be the same as passed in case of rectification in same year except that wherever any Income or Expenses a/c. is involved, the Debit/Credit will be made in PandL adjustment a/c. and not in the Income or Expenses a/c.
• Otherwise, this year’s profit will be affected by the errors of last year.
• The balance in PandL adjustment a/c. will be transferred to capital a/c in the case of proprietorship or partnership concern or to the Profit and Loss Appropriation account in the case of a company.

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Forming Rectification Entry:

Steps to be followed for solving a rectification problem are as follows:

• An account is not debited or less debited ¬ debit it
• An account is not credited or less credited ¬ credit it
• If an account is wrongly debited or more debited ¬ credit it
• If an account is wrongly credited or more credited ¬ debit it
• After making the above if the double entry is not yet completed, then make it a double entry by debiting or crediting the difference to suspense a/c.
• If rectification is being done in a subsequent year then in place of the income and expenses account, P and L adjustment account will be debited or credited, as the case may be. Must Check Going Concern Concept.