Understanding Accounting Errors, How to Detect and Prevent Them

What Is an Accounting Error?

An accounting error is an error in an accounting entry that was not intentional. When spotted, the error or mistake is often immediately fixed. If there is no immediate resolution, an investigation into the error is conducted. An accounting error should not be confused with fraud, which is an intentional act to hide or alter entries for the benefit of the firm. Although there are numerous types of errors, the most common accounting errors are either clerical mistakes or errors of accounting principle.

Understanding Accounting Errors

Accounting errors are unintentional bookkeeping errors and are sometimes easy to identify and fix. For example, if the debits and credits don't add up to the same amount in the trial balance, an accountant can easily see what account is inaccurate. The trial balance is a type of worksheet that accountants use to record the debit and credit entries. The totals from the trial balance are later carried over onto the financial statements at the end of the reporting period. However, there are instances where accounting errors exist, but the trial balance is not out of balance, which can be more difficult to identify and fix the errors.

Types of Accounting Errors

Some businesses such as banks and retailers who handle great deals of cash can inadvertently issue the wrong change or make errors in counting money. Variances between expected and actual amounts are called "cash-over-short." This account is kept as part of the company's income statement.

There are numerous other types of accounting errors, and some of the most common mistakes are listed below.

Error of Original Entry

An error of original entry is when the wrong amount is posted to an account. The error posted for the wrong amount would also be reflected in any of the other accounts related to the transaction. In other words, all of the accounts involved would be in balance but for the wrong amounts.

Error of Duplication

Error of duplication is when an accounting entry is duplicated, meaning it's debited or credited twice for the same entry. For example, an expense that was debited twice for the same amount would be an error of duplication.

Error of Omission

An error of omission is when an entry wasn't made even though a transaction had occurred for the period. For example, an accounts payable account, which are the short-term debts that companies owe suppliers and vendors, is not credited when goods were purchased on credit. This is common when there are many invoices from vendors that need to be recorded, and the invoice gets lost or not recorded properly.

An error of omission could also include forgetting to record the sale of a product to a client or revenue received from accounts receivables. Accounts receivables reflect the money owed by customers to a company for products sold.

Error of Entry Reversal

Error of entry reversal is when the accounting entry is posted in the wrong direction, meaning a debit was recorded as a credit or vice versa. For example, cost of goods sold, which contains raw materials and inventory, is credited instead of debited and finished inventory is debited instead of credited.

Error of Principle

Error of accounting principle occurs when an accounting principle is applied in error. For example, an equipment purchase is posted as an operating expense. The operating expenses are the day-to-day expenses and wouldn't include a fixed-asset purchase. Also, asset purchases should be recorded on the balance sheet while operating expenses should be recorded on the income statement.

Error of Commission

Error of commission is an error that occurs when a bookkeeper or accountant records a debit or credit to the correct account but to the wrong subsidiary account or ledger. For example, money that has been received from a customer is credited properly to the accounts receivable account, but to the wrong customer. The error would show on the accounts receivable subsidiary ledger, which contains all of the customers' invoices and transactions.

A payment to a vendor that's recorded as an accounts payable, but to the wrong invoice or vendor is also an error of commission. The error would show as posted to the wrong vendor on the accounts payable subsidiary ledger.

Compensating Error

Compensating error is when one error has been compensated by an offsetting entry that's also in error. For example, the wrong amount is recorded in inventory and is balanced out by the same wrong amount being recorded in accounts payable to pay for that inventory.

Detection and Prevention of Accounting Errors

Unintentional accounting errors are common if the journal keeper is not careful or the accounting software is outdated. The discovery of such errors usually occurs when companies conduct their month-end book closings. Some companies may perform this task at the end of each week. Most errors, if not all, can be corrected fairly easily.

An audit trail may be necessary if a material discrepancy cannot be resolved quickly. The normal method to handle immaterial discrepancies is to create a suspense account on the balance sheet or net out the minor amount on the income statement as "other."

Keeping track of invoices to customers and from vendors and ensuring they're entered immediately and properly into the accounting software can help reduce clerical errors. Monthly bank reconciliation can help to catch errors before the reporting period at the end of the quarter or fiscal year. A bank reconciliation is a comparison of a company's internal financial records and transactions to the bank's statement records for the company.

Of course, no company can prevent all errors, but with proper internal controls, they can be identified and corrected relatively quickly.