Comprehensive Study Guide on Correction of Errors and Suspense Accounts

Introduction to Correction of Errors and Suspense Accounts

In the course of financial record-keeping, additions are frequently made, and wrong positions are corrected following systematic reviews. A trial balance is intended to show the equality of debits and credits, but it does not reveal all errors. When a trial balance does not balance, an account is introduced to accommodate the discrepancy temporarily. This account is known as a suspense account, and it serves to "suspend" the error until the issue is subsequently resolved. The primary objective of studying these corrections is to be able to raise simple journal transactions and post those journals to the appropriate books of account accurately.

Errors in bookkeeping are mistakes made during entries, the balancing of accounts, or the extraction of the trial balance. It is mandatory to correct these errors as soon as they are discovered because left uncorrected, they result in the understating or overstating of both profit and the financial position of the business. In financial accounting, these errors are classified into two basic categories: errors that do not affect the trial balance total and errors that do affect the trial balance total.

Errors Not Affecting the Trial Balance Total

Despite the listed totals of all debit ($DR$) and credit ($CR$) balances agreeing, certain errors may exist because the double-entry principle was still technicality complied with. There are six primary types of such errors:

1. Error of Principle: This occurs when a transaction is recorded in the wrong class of account. For example, purchasing a motor vehicle for $₦15,000,000$ and entering it in the motor expenses account instead of the fixed asset account.

2. Error of Omission (identified in transcript as Error of Commission): This occurs when a transaction has been completed but not recorded in the books at all. For example, a cash payment of $2,000,000$ to Mr. Samuel that has not been recorded.

3. Error of Commission: This occurs when a transaction is posted to the correct side and the correct class of account, but to the wrong personal account or ledger. For example, selling goods worth $₦100,000,000$ to Babatunde but posting it to Babaotu’s account.

4. Compensating Error: This occurs when different errors of the same amount on opposite sides cancel each other out. For example, if a sales account is erroneously credited with $₦25,000,000$ and an advertising account is erroneously debited with the same amount of $₦25,000,000$.

5. Error of Complete Reversal of Entries: This occurs when a transaction is posted with the correct amount to the correct accounts, but on the wrong sides. To correct this, the original amount must be doubled in the journal entry. For example, paying $₦500,000$ cash to Florence but crediting her account and debiting the cash account.

6. Error of Original Entry: This occurs when a transaction is posted using the wrong amount from the start. For example, receiving $₦5,000,000$ cash from Adefeso but recording it in the books of account as $₦15,000,000$.

These errors are corrected by initiating journal entries that remove the previous wrong entries and restore accounts to their expected levels. For instance, if Babaotu was incorrectly debited instead of Babatunde, the correction would involve debiting Babatunde and crediting Babaotu.

Illustration: Kuskure & Sons Audit Findings

The accountant of Kuskure & Sons extracted a trial balance that agreed, but auditors for the year ended $20X4$ discovered several errors that required correction:

 Purchases worth $₦800$ on credit from Chika posted to Chikaku’s account. Correction: Dr. Chikaku $₦800$, Cr. Chika $₦800$.

 Goods worth $₦500$ sold on credit to Musa entered in Moses account. Correction: Dr. Musa $₦500$, Cr. Moses $₦500$.

 A cheque of $₦1,800$ for advertisements posted to the cash column of the cashbook. Correction: Dr. Advertisement $₦1,800$, Cr. Cash $₦1,800$.

 Credit purchases of $₦980$ from A. Dogo entered as $₦890$. Correction: Dr. Purchases $₦90$, Cr. A. Dogo $₦90$. ($980 - 890 = 90$).

 Rent paid ($₦6,500$) debited to insurance account. Correction: Dr. Rent $₦6,500$, Cr. Insurance $₦6,500$.

 Wages for casual workers ($₦5,500$) omitted from books. Correction: Dr. Casual Wages $₦5,500$, Cr. Cash $₦5,500$.

 Plant and machinery acquisition ($₦9,500$) posted to purchases. Correction: Dr. Plant \& Machinery $₦9,500$, Cr. Purchases $₦9,500$.

 Sales day book overstated by $₦8,000$ and purchases journal also affected. Correction: Dr. Sales $₦8,000$, Cr. Purchases $₦8,000$.

 Cash payment to Ogene ($8,000$) debited to cashbook and credited to Ogene. Correction: Dr. Cash $₦8,000$, Cr. Ogene $₦8,000$.

 Sales invoice for $₦2,500$ omitted. Correction: Dr. Musa (Receivables) $2,500$, Cr. Sales $2,500$.

 Cash withdrawn from bank ($₦3,000$) entered in cash column (Cr) and bank column (Dr). Correction: Dr. Bank $₦3,000$, Cr. Cash $₦3,000$.

Errors Affecting the Trial Balance Total

When the double-entry principle is not properly observed, the debit and credit totals of the trial balance will not match. Errors causing this include partial omission, clerical mal-calculations, oversighting, and transposition errors (e.g., recording $₦107,000$ as $₦170,000$). Specific clerical errors include understating an account (if an expense is understated, profit increases, requiring a deduction from profit) or overstating an account (if an expense is overstated, profit decreases, requiring an addition to profit).

To resolve a trial balance that fails to agree, the following steps should be followed:

1. Re-add the trial balance balances to check for addition errors.
2. Calculate the exact difference between the two sides.
3. Halve the difference ($1/2$) and look for that specific amount on the wrong side of the trial balance.
4. Examine control accounts on the sales and purchases ledgers if possible.
5. Check all entries for the month individually.
6. If the error remains hidden, open a suspense account to hold the difference before making corrections.

The Suspense Account and Profit Adjustments

A suspense account is a temporary holding account for variances when total debits and credits do not match. If the balance is a debit, it is shown on the balance sheet under current assets; if it is a credit, it is shown under current liabilities. This account must be cleared as soon as errors are located. Correcting entries for errors affecting the trial balance are passed through the suspense account, while those not affecting it are not.

When corrections occur after draft final accounts are drawn, any entry to a nominal account (income or expense) affects the draft profit. A debit entry to a nominal account (such as an expense) reduces profit, while a credit entry to a nominal account (such as income) increases profit. Specifically, in the income account, a debit implies income has fallen (reducing profit), and a credit implies income has increased (increasing profit). In the expense account, a debit implies expenses have risen (reducing profit), and a credit implies expenses have fallen (increasing profit).

Illustrative Case Study: Ganiyu’s Balance Sheet Correction

Ganiyu, an engineering firm proprietor, has a balance sheet as of December 31st, 20X8, showing a suspense account balance of $₦1,465$ and a profit and loss account of $27,613$. Several errors were identified for rectification:

• A page total in the purchase day book was carried forward as $₦6,985$ instead of $6,895$.
• Interest on a $₦20,000$ long-term loan at $10\%$ ($₦2,000$) remains unpaid.
• Stock sheets were overcast by $₦2,000$.
• An investment of $₦2,500$ was omitted from the trial balance.
• Cash in hand was recorded as $₦550$ but should be $₦55$.
• A supplier invoice for $250$ was included in stock and purchases but not the personal ledger.
• An item in the Sales Day Book for $₦225$ was posted to the personal account as $₦425$.

Correction involves adjusting the suspense account to zero and producing a corrected balance sheet reflecting accurate asset, liability, and capital values.

Detailed Error Scenarios: Good-Success & Sons Ltd and Oluwa & Sons Ltd

In the case of Good-Success & Sons Ltd, the trial balance included a suspense account of $₦98,700$. Errors included cash sales of $₦61,000$ wrongly posted as $₦16,000$ in the sales account (though correct in the cashbook), and a mortgage loan of $₦49,590$ that was not entered into the loan account despite being in the cashbook. Furthermore, a customer, Mr. Jango, had $₦5,000$ wrongly debited to his account instead of credited for a payment received.

For Oluwa-Tomi & Sons Ltd, the suspense account was raised at $₦49,400$. Errors discovered included accountant salaries of $₦3,300$ omitted from the books, and sales of $₦30,500$ by cheque entered in the sales account as only $₦3,000$. Additionally, a director’s loan of $₦24,595$ was omitted from the loan account entirely. Correcting these involves using the journal proper to update relevant ledger accounts and the suspense account until the trial balance is revised and balanced.