Presentation on theme: "Lesson 2 Control Accounts and Correction of Errors."— Presentation transcript:
Lesson 2 Control Accounts and Correction of Errors
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.
Learning Outcomes The following areas will be covered in this lecture n ote L 02 - Identify and rectify errors made before and during the preparation of financial statements
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
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.
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, 1.Sales ledger control account 2.Purchase ledger control account 3.salaries and wages control account etc.
Control accounts contd. Purpose of control accounts 1.Control accounts help to check arithmetical accuracy 2.It helps to provide the total of debtors and creditors quickly when needed 3.Control accounts help to identify where the errors occurred when the control accounts and individual accounts to not match
Control accounts contd. Example Prepare the relevant control account and individual accounts in the subsidiary ledger. JohnRebeccaVickyTim Opening balance £1,500£2,000£520- Sales£15,000£6,000£1,500£5,000 Cash received£12,000£2,000-£1,000 Goods returned -£1,000-£500
Control accounts contd. Answer
Control accounts contd. Answer – Subsidiary Ledger
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 John4,500 David5,000 Vicky2,020 Rick3,500 15,020
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
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: 1.John omitted an invoice of £20, A payment of £10,000 was not recorded in the control account 3.A cash payment of another £10,000 was missed when recording in the subsidiary ledger. 4.Goods returned worth £8,000 was not recorded in Jason’s individual account.
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
Control accounts to avoid errors contd. Answer Adjustments to control account Adjustments to individual balances Adjustment£ Extracted Balance128,000 + Omitted invoice20,000 - Cash payment(10,000) - Goods returned(8,000) 130,000
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 Use of trial balance to detect errors DebitCredit AssetsLiabilities ExpensesIncome Capital
Example Use of trial balance to detect errors contd.
Use of trial balance to detect errors 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
Correction of errors There are mainly two types of errors. Errors Not Affecting Trial Balance Agreement 1.Error of Omission 2.Error of Commission 3.Error of Principle 4.Compensating Error 5.Transposition errors Errors Affecting Trial Balance Agreement
Types of errors 1.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. Trade receivables A/C Dr Sales A/C (Recording the omitted credit sale) 10,000 10,000
Types of errors Contd. 2.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. 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 10,000
Types of errors Contd. 3.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 10,000
Types of errors Contd. 4.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 5,000
Types of errors Contd. 5.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 4,500
Types of errors Contd. Errors affecting trial balance 1.When an error is made in only one ledger account, it will cause a ‘difference’ in the trial balance. 2.If two or more accounts have errors with different amounts, then it will affected the balance sheet. 3.When correcting these errors we have to open a suspense account.
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: 1.A bookkeeper is unsure where to post an item 2.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
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. 1.The cash account was under-casted by £200 2.A cash receipt of £400 from trade receivables was recorded correctly in the cash account, but was not recorded in the receivables account 3.The salary of Reeds which amounted to £250 was posted as £500 the salary account
Correction of errors contd. Answer Error 1 Cash A/C Dr Suspense A/C (Rectifying the error of understating the sales value in books ) Suspense account Balance450 Cash200
Correction of errors contd. Answer Error 2 Suspense A/C Dr Receivables A/C (Rectifying the error of understating the sales value in books ) Suspense account Receivables400Balance450 Cash200
Correction of errors contd. Answer Error 3 Suspense A/C Dr Salary A/C (Rectifying the error of understating the sales value in books ) Suspense account Receivables400Balance450 Salary250Cash
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
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
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
Reconciliation of Profit contd. Example John prepared financial statements for 201X and calculated a profit of £15,000. He later recognised the following errors. 1.Sales account was understated by £1,000 2.Salary paid to A David was debited to the account of A Davis 3.Electricity bill of £500 was omitted from the records. 4.£2,000 rent receipt was recorded as an rent expense. Calculate the revised profit
Reconciliation of Profit contd. Answer Statement of profit reconciliation Item£ Profit calculated15,000 + Understated sales value1,000 + Rent income2,000 + Reduction in rent expense2,000 - Electricity expense(500) Revised profit19,500
References 1.Weygandt, J.J., Kimmel, P.D., Kieso, D.E., Accounting Principles. 10 th ed. Danvers : John Wiley & Sons, Inc. 2.Harrison, W.T. Jr., Horngren, C.T., Thomas, C.W., Financial Accounting. 8 th ed. London : Pearson Education 3.Lunt, H., CIMA Official Learning System Fundamentals of Financial Accounting. London : CIMA Publishing Elsevier