Presentation on theme: "Lesson 2 Control Accounts and Correction of Errors"— Presentation transcript:
1Lesson 2 Control Accounts and Correction of Errors
2DisclaimerPlease 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.
3Learning OutcomesThe following areas will be covered in this lecture note L 02 - Identify and rectify errors made before and during the preparation of financial statements
4Contents Control accounts Control accounts to avoid errors Use of trial balance to detect errorsCorrection of errorsIncorporate corrected figures to financial statementReconciliation of Profit
5Control 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 systemControl 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.
6Control 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 accountPurchase ledger control accountsalaries 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 accountsPurchase ledger control account - summarises the individual supplier accountssalaries and wages control account - summarises the salary information
7Control accounts contd. Purpose of control accountsControl accounts help to check arithmetical accuracyIt helps to provide the total of debtors and creditors quickly when neededControl accounts help to identify where the errors occurred when the control accounts and individual accounts to not matchControl 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.
8Control accounts contd. ExamplePrepare the relevant control account and individual accounts in the subsidiary ledger.JohnRebeccaVickyTimOpening balance£1,500£2,000£520-Sales£15,000£6,000£5,000Cash received£12,000£1,000Goods returned£500
11Control accounts contd. AnswerBalance extracted at the end of the periodExtracted balance figure is equal to the final balance of the control accountJohn4,500David5,000Vicky2,020Rick3,50015,020
12Control accounts to avoid errors The final balance of the control account and the extracted total of the individual balances should be equalIf there is a difference, then there is an error in the accounting processYou must find the reasons for the differenceThe 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 processHowever, 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.
13Control accounts to avoid errors contd. ExampleJohn 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 accountA 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.
14Control accounts to avoid errors contd. Notes to the answerError 1 – The sales invoice is completely omitted. Therefore you must record this in both control account and individual accountError 2 – This error happened only in the control accountError 3 and 4 – Both these errors will only effect the individual account balances. Therefore they need to corrected in the subsidiary ledger
15Control accounts to avoid errors contd. AnswerAdjustments to control accountAdjustments to individual balancesAdjustmentExtracted Balance128,000+ Omitted invoice20,000- Cash payment(10,000)- Goods returned(8,000)130,000Control account balance and the total of individual accounts should be equal after the reconciliation.
16Use of trial balance to detect errors Trial balance is a worksheet that show all the final balances of ledger accountsThe balances should be entered as follows.The total of debit side and credit side should be equalTrial balance will make sure that the accounting process is mathematically correctDebitCreditAssetsLiabilitiesExpensesIncomeCapitalThe 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.
17Use of trial balance to detect errors contd. ExampleThe 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.
18Use 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 equalIf it is not equal, there is an error or errors in the processThey need to be corrected before preparing the financial statementsIf 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 correctedHowever, 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.
19Correction of errors There are mainly two types of errors. Errors Not Affecting Trial Balance AgreementError of OmissionError of CommissionError of PrincipleCompensating ErrorTransposition errorsErrors Affecting Trial Balance Agreement
20Types of errorsError 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 DrSales A/C(Recording the omitted credit sale)10,000
21Types 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 DrN Simon A/C(Rectifying the error of recording credit sales to N Simon in the accounts of M Simon)10,000
22Types 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 DrMotor Vehicle A/C(Rectifying the error of recording credit sales to N. Simon in the accounts of M. Simon)10,000This 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.
23Types 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 accountSalary A/C DrSales A/C(Rectifying the error of understating sales and not recording salaries)5,000This is where one error is compensated with another error(s). Therefore this error would not affect the trial balance.
24Types 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 DrSales A/C(Rectifying the error of understating the sales value in books )4,500This 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.
25Types 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.
26Correction of errors contd. Suspense accountA suspense account is a temporary account in the general ledgerSuspense account could be opened in 2 occasions:A bookkeeper is unsure where to post an itemThere is a difference in a trial balance. A suspense account is opened with the amount of the difference, just to agree the trial balanceSuspense 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.
27Correction of errors contd. Suspense accountExample: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 £200A cash receipt of £400 from trade receivables was recorded correctly in the cash account, but was not recorded in the receivables accountThe salary of Reeds which amounted to £250 was posted as £500 the salary accountThe 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.
28Correction of errors contd. AnswerError 1Cash A/C DrSuspense A/C(Rectifying the error of understating the sales value in books )200Suspense accountBalance450Cash200To 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.
29Correction of errors contd. AnswerError 2Suspense A/C DrReceivables A/C(Rectifying the error of understating the sales value in books )400Suspense accountReceivables400Balance450Cash200To 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.
30Correction of errors contd. AnswerError 3Suspense A/C DrSalary A/C(Rectifying the error of understating the sales value in books )250Suspense accountReceivables400Balance450Salary250Cash200650To 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.
31Incorporate corrected figures to financial statement You must prepare the trial balance before financial statements. If it doesn’t get equal, there are errorsAny errors recognised should be correctedYou must pay an attention to the account values that are correctedUpdate the trial balance with the corrected values and see whether the two sides are equal
32Incorporate corrected figures to financial statement contd. Now the trial balance must be correct and debit side will be equal with the credit sideThen the financial statements should be prepared. They will be based on the corrected figures now
33Reconciliation of Profit Sometimes, errors are identified even after preparing the financial statementsIn that situation, we must correct the calculated profit, when we correct the figures
34Reconciliation of Profit contd. ExampleJohn prepared financial statements for 201X and calculated a profit of £15,000. He later recognised the following errors.Sales account was understated by £1,000Salary paid to A David was debited to the account of A DavisElectricity bill of £500 was omitted from the records.£2,000 rent receipt was recorded as an rent expense.Calculate the revised profitWhen 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.
35Reconciliation of Profit contd. AnswerStatement of profit reconciliationItemProfit calculated15,000+ Understated sales value1,000+ Rent income2,000+ Reduction in rent expense- Electricity expense(500)Revised profit19,500
36ReferencesWeygandt, 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 EducationLunt, H., CIMA Official Learning System Fundamentals of Financial Accounting. London : CIMA Publishing Elsevier