1. Lesson 2 Control Accounts and Correction of Errors

2. Disclaimer
Please kindly note that these are reference materials only. Candidates are required to refer to recommended books in order to supplement their knowledge and understanding of the module.

3. Learning Outcomes
The following areas will be covered in this lecture note L 02 - Identify and rectify errors made before and during the preparation of financial statements

4. Contents Control accounts Control accounts to avoid errors
Use of trial balance to detect errors
Correction of errors
Incorporate corrected figures to financial statement
Reconciliation of Profit

5. Control accounts A control account is a summary account.
It summarise the values of all similar accounts.
Control account will be a part of the double entry system
Control account will not reflect values of individual accounts.
A control account do not reflect individual values. It adds all the similar items and post the final value in the control account. This is the reason why it is called a summary account.

6. Control accounts contd.
Therefore you must separately record individual values in their respective accounts in the subsidiary ledger. These individual accounts are known as memorandum accounts.
Most common control accounts are,
Sales ledger control account
Purchase ledger control account
salaries and wages control account etc.
Memorandum Accounts – These accounts are not a part of the double entry system. You must keep them for references purposes only. This is because company need to keep a track about individual items as well. For example if one of our customers inquire about his account balance, we should be able to tell it within few minutes. This individual value cannot be found out from the control account.
Sales ledger control account - summarises the individual customer accounts
Purchase ledger control account - summarises the individual supplier accounts
salaries and wages control account - summarises the salary information

7. Control accounts contd.
Purpose of control accounts
Control accounts help to check arithmetical accuracy
It helps to provide the total of debtors and creditors quickly when needed
Control accounts help to identify where the errors occurred when the control accounts and individual accounts to not match
Control accounts will confirm whether the transactions are arithmetically correct. The total of the individual balances should be equal to the final balance of the control account.
Control account would show the final value of debtors and creditors etc. This is useful when preparing trial balance and making business decisions.
Control account help to identify the ledger or ledgers in which errors have been made when there is a discrepancy between the total account and the total of the individual ledger balances.

8. Control accounts contd.
Example
Prepare the relevant control account and individual accounts in the subsidiary ledger.
John
Rebecca
Vicky
Tim
Opening balance
£1,500
£2,000
£520 -
Sales
£15,000
£6,000
£5,000
Cash received
£12,000
£1,000
Goods returned
£500

9. Control accounts contd.
Answer

10. Control accounts contd.
Answer – Subsidiary Ledger

11. Control accounts contd.
Answer
Balance extracted at the end of the period
Extracted balance figure is equal to the final balance of the control account
John
4,500
David
5,000
Vicky
2,020
Rick
3,500
15,020

12. Control accounts to avoid errors
The final balance of the control account and the extracted total of the individual balances should be equal
If there is a difference, then there is an error in the accounting process
You must find the reasons for the difference
The differences needs to be adjusted. The adjustments may have to be done in the control account, the individual accounts or sometimes in both. This process is known as the reconciliation process
However, this approach does not ensure that the accounting figures is free from errors.
For example lets assume that a transaction was recorded on the correct side, but on the wrong individual accounts. Still the control account balance and the total of individual accounts would be equal. But we know that there is an error.

13. Control accounts to avoid errors contd.
Example
John maintains a sales ledger control account. On 31 March 20X1, the balance on the control account was £120,000. The total of individual balances of the sales ledger was £128,000. The reasons for the difference are as follows:
John omitted an invoice of £20,000.
A payment of £10,000 was not recorded in the control account
A cash payment of another £10,000 was missed when recording in the subsidiary ledger.
Goods returned worth £8,000 was not recorded in Jason’s individual account.

14. Control accounts to avoid errors contd.
Notes to the answer
Error 1 – The sales invoice is completely omitted. Therefore you must record this in both control account and individual account
Error 2 – This error happened only in the control account
Error 3 and 4 – Both these errors will only effect the individual account balances. Therefore they need to corrected in the subsidiary ledger

15. Control accounts to avoid errors contd.
Answer
Adjustments to control account
Adjustments to individual balances
Adjustment
Extracted Balance
128,000
+ Omitted invoice
20,000
- Cash payment
(10,000)
- Goods returned
(8,000)
130,000
Control account balance and the total of individual accounts should be equal after the reconciliation.

16. Use of trial balance to detect errors
Trial balance is a worksheet that show all the final balances of ledger accounts
The balances should be entered as follows.
The total of debit side and credit side should be equal
Trial balance will make sure that the accounting process is mathematically correct
Debit
Credit
Assets
Liabilities
Expenses
Income
Capital
The accounts are recorded using the double entry theory. So every transaction will have a debit entry and a credit entry of the same value. Therefore when the trial balance is prepared, the debit side and the credit side needs to be equal. But it will only confirm that the figures are mathematically correct.
For example if a transaction is recorded completely using wrong figures, still the trial balance will get equal.

17. Use of trial balance to detect errors contd.
Example
The above example shows that the account balances are listed following the double entry theory. The assets and expenses are debited while the liabilities, income and capital are credited.

18. Use of trial balance to detect errors contd.
If there are no errors, the debit total and the credit total of the trial balance will be equal
If it is not equal, there is an error or errors in the process
They need to be corrected before preparing the financial statements
If there is a difference in the trial balance, it will be moved to a special account called “the suspense account”
Suspense account will be closed when the errors are corrected
However, this approach does not ensure that the accounting figures are free from errors. Sometimes the trial balance would be equal even with errors.
For example lets assume that a transaction was recorded on the correct side of the account, but on the wrong individual accounts. Still the debit side and the credit side of the trial balance will be equal. But we know that there is an error.

19. Correction of errors There are mainly two types of errors.
Errors Not Affecting Trial Balance Agreement
Error of Omission
Error of Commission
Error of Principle
Compensating Error
Transposition errors
Errors Affecting Trial Balance Agreement

20. Types of errors
Error of Omission ─ A transaction is completely left out or omitted from the company books. You must enter the omitted entries.
Example: A credit sale of £10,000 to Simon was completely omitted in accounts.
The errors committed by not recording a transaction either in the book of original entry or in the ledger book are errors of omission. In this example, it was completely omitted. Therefore the trial balance will not be affected.
Trade receivables A/C Dr
Sales A/C
(Recording the omitted credit sale)
10,000

21. Types of errors Contd.
Error of Commission – This includes posting on the wrong side of ledger accounts, writing wrong amounts or calculating wrong total of any account. You must correct the wrong entry.
Example: A credit sale of £10,000 to N Simon was credited to the account of M Simon.
If accountant passes the wrong entry or posts wrong side of ledger accounts or writes wrong amount or calculates wrong total of any account, then these types of mistakes are called errors of commission. Some of errors of commission can easy find out by making trial balance but some errors of commission can not find out through trial balance.
M Simon A/C Dr
N Simon A/C
(Rectifying the error of recording credit sales to N Simon in the accounts of M Simon)
10,000

22. Types of errors Contd.
Error of Principle – This is where an entry is made to the wrong classification of account. You must correct the wrong entry.
Example: A motor vehicle repair which cost £10,000 was debited to the motor vehicle account.
Motor Vehicle repair cost A/C Dr
Motor Vehicle A/C
(Rectifying the error of recording credit sales to N. Simon in the accounts of M. Simon)
10,000
This is where a transaction is posted by violating the principles of accounting. Lack of knowledge about accounting is the main reason for this type of errors.

23. Types of errors Contd.
Compensating Errors – This is where one error is cancelled out by another error or more errors.
Example: The sales account was understated by £5,000 while the salary of £5,000 of an employee was not recorded in the salary account
Salary A/C Dr
Sales A/C
(Rectifying the error of understating sales and not recording salaries)
5,000
This is where one error is compensated with another error(s). Therefore this error would not affect the trial balance.

24. Types of errors Contd.
Transposition Error  – This is where entries are made to the correct account but with wrong figures. This error is caused by reversing two or more digits of an amount .
Example: The sales of £6,100 was debited to cash and credited to sales as £1,600.
Cash A/C Dr
Sales A/C
(Rectifying the error of understating the sales value in books )
4,500
This is a simple mathematical error. This error is caused by reversing two or more digits of an amount while posting a transaction. If the error happened in both ledger accounts, then it will not be revealed from the trial balance.

25. Types of errors Contd. Errors affecting trial balance
When an error is made in only one ledger account, it will cause a ‘difference’ in the trial balance.
If two or more accounts have errors with different amounts, then it will affected the balance sheet.
When correcting these errors we have to open a suspense account.

26. Correction of errors contd.
Suspense account
A suspense account is a temporary account in the general ledger
Suspense account could be opened in 2 occasions:
A bookkeeper is unsure where to post an item
There is a difference in a trial balance. A suspense account is opened with the amount of the difference, just to agree the trial balance
Suspense account is opened with the intention of correcting the errors as soon as possible. Once the errors are identified and corrected, the trial balance will get closed.

27. Correction of errors contd.
Suspense account
Example:
Joanne prepared the trial balance of her business and the credit side of the trial balance was lesser by £450. Later the following errors were identified.
The cash account was under-casted by £200
A cash receipt of £400 from trade receivables was recorded correctly in the cash account, but was not recorded in the receivables account
The salary of Reeds which amounted to £250 was posted as £500 the salary account
The trial balance difference has occurred in the credit side. That is the reason it’s lesser than the debit side. So the begining balance of the suspense account will recorded on the credit side.

28. Correction of errors contd.
Answer
Error 1
Cash A/C Dr
Suspense A/C
(Rectifying the error of understating the sales value in books )
200
Suspense account
Balance
450
Cash
200
To correct this error, we must add £200 to the cash account. The other entries are posted correctly. So the remaining entry will be recorded in the suspense account.

29. Correction of errors contd.
Answer
Error 2
Suspense A/C Dr
Receivables A/C
(Rectifying the error of understating the sales value in books )
400
Suspense account
Receivables
400
Balance
450
Cash
200
To correct this error, we must record the cash receipt in the receivables account. Cash receipt will reduce the receivables, so it is recorded in the credit side. The question mentions that the entry in cash account was posted correctly. So the remaining entry will be recorded in the suspense account.

30. Correction of errors contd.
Answer
Error 3
Suspense A/C Dr
Salary A/C
(Rectifying the error of understating the sales value in books )
250
Suspense account
Receivables
400
Balance
450
Salary
250
Cash
200
650
To correct this error, we must deduct the additional amount mentioned as payments to Reeds from the salary account. The question does not mentions that the entry in was entered as £500 in the cash account as well. So we assume that it is recorded in the cash account correctly. So the remaining entry will be recorded in the suspense account.

31. Incorporate corrected figures to financial statement
You must prepare the trial balance before financial statements. If it doesn’t get equal, there are errors
Any errors recognised should be corrected
You must pay an attention to the account values that are corrected
Update the trial balance with the corrected values and see whether the two sides are equal

32. Incorporate corrected figures to financial statement contd.
Now the trial balance must be correct and debit side will be equal with the credit side
Then the financial statements should be prepared. They will be based on the corrected figures now

33. Reconciliation of Profit
Sometimes, errors are identified even after preparing the financial statements
In that situation, we must correct the calculated profit, when we correct the figures

34. Reconciliation of Profit contd.
Example
John prepared financial statements for 201X and calculated a profit of £15,000. He later recognised the following errors.
Sales account was understated by £1,000
Salary paid to A David was debited to the account of A Davis
Electricity bill of £500 was omitted from the records.
£2,000 rent receipt was recorded as an rent expense.
Calculate the revised profit
When correcting this error, the sales will increase. So it will increase the profits.
When correcting this error, we will record the salary payment in the correct. However the correct double entry is already followed (although in wrong accounts). Therefore it will not affect the profits.
When correcting this error, we introduce a new expense. So this would decrease the profits.
When correcting this error, first we must correct the wrong expense entry. It would increase the profits. Then we post the correct income entry. That would also increase the profits. Hence the impact would be doubled once the error is corrected.

35. Reconciliation of Profit contd.
Answer
Statement of profit reconciliation
Item
Profit calculated
15,000
+ Understated sales value
1,000
+ Rent income
2,000
+ Reduction in rent expense
- Electricity expense
(500)
Revised profit
19,500

36. References
Weygandt, J.J., Kimmel, P.D., Kieso, D.E., Accounting Principles. 10th ed. Danvers : John Wiley & Sons, Inc.
Harrison, W.T. Jr., Horngren, C.T., Thomas, C.W., Financial Accounting. 8th ed. London : Pearson Education
Lunt, H., CIMA Official Learning System Fundamentals of Financial Accounting. London : CIMA Publishing Elsevier