Types of Accounting Error

Definition of Accounting Error

Accounting is significantly driven by human activities and thus, there are chances that errors are made in the process. Accounting error is simply an error made by the accounting executives while accounting the financial data into the system. The existence of accounting errors will provide inaccurate results to the reader of financial statements. However, errors cannot be easily linked to fraud. Errors can be classified as frauds only if the errors were significant in nature carried with an intention to earn personal gains or profits. The different types of accounting errors are error of principle, clerical errors, and compensatory errors. The most common type of accounting mistake is misclassification of accounts under different categories, data entry errors, and clerical errors.

Accounting error is simply an error made by the accounting executives while accounting the financial data into the system, the existence of which will provide inaccurate results to the reader of financial statements and such errors may or may not be intentional, may or may not result in fraud, with or without the connivance of the higher management.

What is Error in Accounting?

Accounting is a continuous process involving human intelligence and a medium-scale of the level of automation. However, automated accounting processes require periodical review by department heads.

• Accounting is significantly driven by human activities and thus, there are chances that errors are made in the process.
• Such errors become significant in value and repetitive in nature if appropriate review and actions are not taken at timely intervals.
• Errors cannot be easily linked to frauds. Errors can be classified as frauds only if the errors were significant in nature carried with an intention to earn personal gains or profits.
• Timely resolution of errors will help the entity to save from the defects in the financial statements.

Type of Error in Accounting

The various types of accounting errors are as follows:

• Error of principle
• Clerical Errors can be further categorized as follows
• Errors of Omission
• Errors of Commission
• Compensating Errors.

The details of each error are explained as follows:

ERROR OF PRINCIPLE

• Error of principle means incorrect treatment of a transaction which leads to violation of accounting policies and procedures. Error of principle is a serious error amongst other errors. Such errors usually occur when the basic concepts of the accounting executive are not clear. It is also called an “input error”.
• However, even if such an error exists, the trial balance will anyways be tallied. Because the debit and credit have affected incorrect accounts. Even computer-based accounting may allow such errors to occur. So as to understand the significance of this error, let’s evaluate through an example.
• A bank provides finance to a capital-intensive company based on investments intangible assets. A capital-intensive company means a company which requires annual cash outflow for fixed assets. Say the banker provides finance for 70% of the value of fixed assets. If the accounting executive records the “purchase of assets” as “expenses debited to profit and loss account”, its fixed assets would remain undervalued and misstated. This results in a lowering of bank finance and a lower level of fixed assets also affect key financial ratios.

CLERICAL ERRORS

• These are simply numeral errors done at the time of accounting. Such errors represent the inaccuracy of accounting executives. These are apparently found while vouching for the bills.

• On the basis of the nature of clerical errors, these can be sub-classified as follows:

• ERROR OF OMISSION:

Omission means to miss out on something while doing an activity. Error of omission thus means to miss out something while doing accounting. There can be a partial omission or complete omission of an accounting transaction.

Partial omission occurs when transactions are recorded on the debit side and not on the credit side or vice-versa. Partial omission will lead to the difference in trial balance since partial omission affects only one of the accounts in the entry. This type of error will not happen in computer-based accounting. For example, a payment made to a creditor. The bank account is credited by the amount but the creditor account is not debited. This way the bank shows an accurate balance and the creditor account is still showing a payable balance.

1. The complete omission is a situation where a transaction has been completely omitted from the books of accounts. A transaction itself has not been recorded. This type of error can still occur in computer-based accounting. For example, purchase of assets not recorded in books, receipt of amount from the customer not recorded in books, etc. These omissions result in undervaluation and understating of the financial statements.

• ERROR OF COMMISSION:

These are arithmetical errors. These errors are found only in the case of manual accounting and not in the case of computer-based accounting. The typical error of commission can be as follows:

1. Incorrect totaling of the ledger balances such that incorrect balance is computed.
2. Posting of $ 4544 in the ledger account while the journal entry was made for $ 5444. This type of error is called a “transposition error”.
3. Crediting the party account for the sale of goods i.e., posting at the wrong side of the ledger account.
4. Typo error in accounting.
5. Giving effect to a party account to whom transaction does not relate.

COMPENSATING ERRORS

• Compensating error means one error automatically rectifies another error unknowingly. These are of the type of principle errors and/or clerical errors.
• Say a sale of the product to Mr. A of $ 2000 was recorded incorrectly in A’s account at $ 200 while revenue was recorded correctly. This will reduce the lower down the debit total by $ 1800. Also, a receipt of $ 2000 from Mr. Q was recorded at $ 200. This second error will lower down the credit total of TB by $ 1800. Overall, the TB is tallied. But the closing balance reflected in each account is incorrect. The classic example covered here is a subsidiary error.
• Compensating errors are the real culprits of accounting inefficacies. These lower down the accounting norms.

ROUNDING ERRORS

Rounding error refers to rounding off done during calculations. For example, the value of foreign currency receivable pound 550,456.6975 entered as 550,456.70. The collective result may change the entire status of receivables. 

ERROR OF REVERSALS

The error of reversal may occur when the account is credited instead of debiting the same or vice-versa. Suppose, an invoice has been generated. We normally debit the receivables and credit the sales account. An error of reversal happens when the debit is given to accounts payable instead of accounts receivables.

Guides for Small Business

Businesses should, first of all, ensure that the accounting is done on computer-based programs and all sorts of manual calculations are stopped.

• Accounting software should be updated in a timely manner. Early discovery of errors will help the accounting staff to improve their efficiencies. Timely discovery can help in the timely correction of mistakes. Imagine a situation wherein the account of an employee is settled due to his reliving the job. In case, the excess amount is shown payable to him, the company has to incur the unrequired cash outflow.
• Businesses should maintain an approving authority to ensure the correct flow of accounting. Also, an audit trail will help to correct the material discrepancy.
• Bank and cash are sensitive accounts for every sort of entity. Hence, a daily cash check should be done. There should be a maker-checker system for bank and cash transactions. Monthly reconciliation of bank balance is necessary.
• Half-yearly or annual confirmation should be taken from third parties to ensure the appropriateness of accounting and communication of balances. Third-party signed confirmations are helpful for quick confirmation of balances.
• All errors cannot be prevented but a strong internal control system will reduce the magnitude of errors.

Most Common Errors in Accounting

Out of the various type of accounting errors done by companies, there are a few accounting errors which are common across all firms.

• Non-recording of transactions or delay in recording of transactions is one of the most common errors in accounting. Sometimes the expenses are left unrecorded and sometimes the purchase transactions not recorded. The magnitude increases when the auditor compares the current year’s figures with last year’s figures.
• Another type of common error is data entry error. These are typical clerical errors that can be rectified only if balance confirmation from third parties is taken.
• Mis-classification of accounts is another most common error. Here, the asset-related account is classified as an “expense-category” account. The revenue-category account is misclassified as a “liability-category” account. Such misclassifications give devastating results when the statement of profit and loss and balance sheet is prepared.