Accounting error

Accounting error refers to an unintentional mistake made during the recording, calculating or reporting of financial transactions in an organization's books of accounts ^[1]. Unlike accounting fraud which involves deliberate manipulation of financial records, accounting errors result from carelessness, lack of knowledge, system failures or simple human oversight. These errors can lead to inaccurate financial statements, compliance issues, incorrect tax calculations and poor business decision making if not detected and corrected in a timely manner.

Historical context

The systematic identification and correction of accounting errors has been an essential part of bookkeeping since the development of double-entry accounting in the late medieval period. Luca Pacioli's treatise on bookkeeping published in 1494 described the principle that total debits must equal total credits and established the trial balance as a fundamental tool for detecting certain types of errors ^[2]. This principle remains the foundation of error detection in modern accounting systems.

As business transactions grew in volume and complexity during the industrial revolution the need for systematic procedures to identify and correct errors became increasingly important. The development of professional accounting standards in the late nineteenth and early twentieth centuries included guidance on how to handle errors discovered in financial records. The establishment of generally accepted accounting principles further codified requirements for error correction and restatement of financial information.

The advent of computerized accounting systems in the latter half of the twentieth century introduced both new sources of errors such as data entry mistakes and programming flaws and new tools for error prevention including automated validation checks and audit trails ^[3]. Modern accounting software incorporates numerous controls designed to prevent common errors though human oversight remains essential.

Classification of errors

Accounting errors can be classified according to several different criteria including their effect on the trial balance, their nature and the accounting element affected ^[4].

By effect on trial balance

One fundamental distinction is whether an error affects the agreement of the trial balance. Errors that affect the trial balance cause total debits to differ from total credits making the error relatively easy to detect though not necessarily easy to locate. These include posting only one side of a transaction, posting the wrong amount to an account, making arithmetic mistakes in account balances and omitting an account from the trial balance.

Errors that do not affect the trial balance leave debits equal to credits despite the underlying mistake. These errors are more difficult to detect because the basic balancing check provides no indication of the problem. Examples include compensating errors, errors of principle, errors of commission to wrong accounts within the same category and complete omissions where an entire transaction is not recorded.

By nature of error

Errors are also classified by their nature into systematic and non-systematic categories. Systematic errors result from flaws in accounting processes or practices that repeat over time such as consistently misapplying an accounting principle or using incorrect depreciation rates. Non-systematic errors are random mistakes like data entry errors or transposition of digits that do not follow a predictable pattern.

Types of accounting errors

Several specific types of errors occur commonly in accounting practice ^[5].

Errors of omission

An error of omission occurs when a transaction that should have been recorded is completely or partially left out of the accounting records. Complete omission means the entire transaction was not recorded in any account. For example a business might fail to record a cash purchase of office supplies resulting in both the expense and the reduction in cash being omitted. Partial omission occurs when one side of a transaction is recorded but the corresponding entry is missed such as recording a sale in the revenue account but failing to record the receivable or cash receipt.

Complete omissions do not affect the trial balance because both the debit and credit are missing. Partial omissions do affect the trial balance because only one side of the entry is missing. Both types can result in material misstatements of financial statements if not detected.

Errors of commission

An error of commission occurs when a transaction is recorded but to the wrong account within the correct category. For example payment received from Customer A might be credited to Customer B's account. The entry correctly affects accounts receivable and cash but the subsidiary records for individual customers are incorrect. Similarly an expense might be recorded to the wrong expense account such as recording telephone expense as utilities expense.

Errors of commission typically do not affect the trial balance because the debits and credits are properly balanced. However they cause incorrect balances in individual accounts which can affect financial analysis and subsidiary ledger accuracy.

Errors of principle

An error of principle occurs when a transaction is recorded in violation of a fundamental accounting principle. The most common example is misclassifying capital and revenue items. Recording the purchase of equipment as an expense rather than an asset violates the matching principle and misstates both the balance sheet and income statement. Conversely recording ordinary repairs as a capital asset improperly inflates the asset base.

Other errors of principle include recording items in the wrong accounting period which violates the periodicity concept, using an inappropriate valuation method and misclassifying items between different financial statement elements. These errors do not affect the trial balance but can significantly distort financial statements.

Compensating errors

Compensating errors occur when two or more separate errors offset each other so that the net effect on the accounts is zero or near zero ^[6]. For example if accounts receivable is overstated by one thousand dollars due to an error and accounts payable is also overstated by one thousand dollars due to a different error the total assets minus liabilities remains correct even though both accounts are misstated.

Compensating errors are particularly dangerous because they cannot be detected through trial balance procedures. The books appear to balance even though individual accounts contain errors. These errors may only be discovered through detailed reconciliations, analytical review or when one of the compensating errors is corrected revealing the other.

Transposition errors

A transposition error occurs when two adjacent digits in a number are accidentally reversed during data entry. For example recording five thousand four hundred seventy-two dollars as five thousand seven hundred forty-two dollars reverses the positions of the four and seven. These errors are common in manual data entry and always produce a difference divisible by nine which provides a useful diagnostic when trying to locate the source of a trial balance discrepancy.

Errors of reversal

An error of reversal occurs when a debit is recorded as a credit or a credit is recorded as a debit. For example recording a payment to a supplier as a debit to cash instead of a credit results in cash being overstated by twice the amount of the payment. Similarly recording a sale as a credit to revenue and a credit to accounts receivable instead of a debit reverses the receivable entry.

Errors of reversal affect the trial balance by doubling the impact of the transaction on the affected accounts. They can be detected when the trial balance fails to agree and accounts show unexpected balances.

Duplication errors

A duplication error occurs when a transaction is recorded twice ^[7]. This might happen when an invoice is entered on two different dates or by two different accounting clerks. Duplication errors cause both the debits and credits to be overstated by the amount of the duplicated transaction. While the trial balance still agrees the accounts contain inflated balances that misstate the true financial position.

Detection of errors

Various methods are used to detect accounting errors ranging from basic arithmetic checks to sophisticated analytical procedures ^[8].

Trial balance review

The trial balance is the primary tool for detecting errors that affect the equality of debits and credits. When total debits do not equal total credits an error exists somewhere in the accounts. The difference between debits and credits provides clues about the nature of the error. A difference divisible by nine suggests a transposition error while a difference divisible by two might indicate an error of reversal. However a balanced trial balance does not guarantee error-free records since many error types do not affect the trial balance totals.

Account reconciliation

Reconciliation compares account balances with independent records to identify discrepancies. Bank reconciliations compare the cash account with bank statements. Accounts receivable reconciliations compare individual customer balances with customer records. Inventory reconciliations compare book quantities with physical counts. These procedures can detect errors that do not affect the trial balance including errors of commission and compensating errors.

Analytical review

Analytical procedures compare account balances and ratios with expectations based on prior periods, budgets or industry benchmarks. Unusual fluctuations or relationships may indicate errors. For example if sales increased but accounts receivable decreased contrary to historical patterns an investigation might reveal unrecorded sales or incorrect receivable entries.

Audit procedures

Both internal audits and external audits employ procedures designed to detect errors. Testing of transactions involves examining source documents, tracing entries through the accounting system and recalculating amounts. Confirmation procedures obtain independent verification of balances from third parties such as customers, suppliers and financial institutions.

Correction of errors

The method for correcting an accounting error depends on when the error is discovered and the nature of the error ^[9].

Correction before posting

If an error is discovered before journal entries are posted to the ledger, correction is relatively simple. The incorrect entry can be crossed out and the correct amount written above with a notation explaining the correction. In computerized systems the entry can be deleted and re-entered correctly before posting.

Correcting journal entries

After entries have been posted to ledger accounts, corrections must be made through formal correcting journal entries that leave a clear audit trail. The correcting entry reverses the effect of the error and records the correct treatment. Full documentation should explain the nature of the error, when it was discovered and the rationale for the correction.

Suspense account

When the trial balance does not agree and the error cannot be immediately located the difference may be temporarily posted to a suspense account ^[10]. This allows the preparation of financial statements while the investigation continues. The suspense account should be cleared when the error is found and corrected. Suspense accounts should not carry balances for extended periods as this indicates unresolved discrepancies.

Restatement

When errors are discovered in financial statements that have already been issued the error must be corrected through restatement if the error is material. Accounting standards require disclosure of the nature of the error, the effect on previously reported amounts and adjustments to beginning retained earnings in the period the error is corrected.

Prevention of errors

While accounting errors cannot be completely eliminated, various controls and practices can significantly reduce their frequency and impact ^[11].

Internal controls

Effective internal controls provide systematic checks that prevent and detect errors. Segregation of duties ensures that multiple people are involved in processing transactions reducing the chance that errors go undetected. Authorization procedures require approval before transactions are recorded ensuring validity. Regular reconciliations identify discrepancies promptly.

Training and competency

Well-trained staff make fewer errors than those lacking adequate knowledge of accounting principles and procedures. Ongoing training keeps staff current with changes in standards and systems. Supervision provides guidance for less experienced personnel and catches errors before they affect financial statements.

Accounting software

Modern accounting software includes numerous features that help prevent errors ^[12]. Validation rules prevent entries where debits do not equal credits. Input masks ensure data is entered in correct formats. Automated posting eliminates transcription errors between journal and ledger. Audit trails record all entries and modifications supporting error investigation.

Review procedures

Regular review of work by supervisors or peers provides an additional check on accuracy. Senior accountants should review journal entries prepared by junior staff. Month-end and year-end closing procedures should include analytical review of account balances and unusual items.

Consequences of accounting errors

Uncorrected accounting errors can have serious consequences for organizations ^[13]:

• Inaccurate financial statements mislead investors, creditors and other stakeholders
• Incorrect tax calculations can result in penalties and interest from tax authorities
• Poor decision making based on faulty financial information
• Compliance violations if errors affect regulated financial reporting
• Wasted resources investigating and correcting errors discovered later
• Reputational damage if material errors require public restatement
• Potential legal liability if errors cause financial harm to third parties

Accounting error — recommended articles

Internal audit — External audit — Quality control — Documentation — Training — Standard — Audit — Decision making — Management

References

• Kieso D.E., Weygandt J.J., Warfield T.D. (2022), Intermediate Accounting, John Wiley & Sons, 18th edition.
• Horngren C.T., Sundem G.L., Elliott J.A. (2021), Introduction to Financial Accounting, Pearson, 13th edition.
• Whittington O.R., Pany K. (2021), Principles of Auditing and Other Assurance Services, McGraw-Hill Education, 22nd edition.
• FASB Accounting Standards Codification Topic 250, Accounting Changes and Error Corrections.
• Romney M.B., Steinbart P.J. (2020), Accounting Information Systems, Pearson, 15th edition.

Footnotes

1. Kieso D.E. et al. (2022), p. 1342
2. Horngren C.T. et al. (2021), p. 68
3. Romney M.B., Steinbart P.J. (2020), pp. 285-290
4. Kieso D.E. et al. (2022), pp. 1343-1348
5. Horngren C.T. et al. (2021), pp. 70-75
6. Kieso D.E. et al. (2022), p. 1346
7. Romney M.B., Steinbart P.J. (2020), p. 292
8. Whittington O.R., Pany K. (2021), pp. 185-195
9. FASB ASC Topic 250, Section 10-45
10. Horngren C.T. et al. (2021), p. 78
11. Romney M.B., Steinbart P.J. (2020), pp. 295-305
12. Romney M.B., Steinbart P.J. (2020), pp. 298-300
13. Kieso D.E. et al. (2022), pp. 1350-1352

Author: Sławomir Wawak