understand the effect of correction of errors on a statement of financial position

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3 Verification of Accounting Records

Learning Objectives

  • Explain why a trial balance is prepared and recognise its limitations.
  • Identify, classify and correct the common errors listed in the Cambridge IGCSE 0452 syllabus.
  • Describe how correcting an error influences profit or loss, capital and the Statement of Financial Position (SFP).
  • Use a suspense account correctly.
  • Prepare a simple bank reconciliation and record the related cash‑book adjustments.
  • Understand the purpose of control accounts and know which details are required for the exam.

3.1 Trial Balance – Purpose, Uses & Limitations

Why a trial balance is prepared

  • To test the arithmetic accuracy of the ledger – total debits must equal total credits.
  • To provide the starting point for preparing the final accounts (income statement and SFP).
  • To help locate posting errors, transposition errors and errors of omission.

Key limitations (Cambridge wording)

LimitationWhat it means
Errors of omission A whole transaction is left out – the trial balance will still balance.
Errors of commission (amounts unequal) Correct accounts are used but the amount recorded is wrong – totals remain equal.
Errors of commission that are equal in debit and credit Two amounts are recorded incorrectly but the total debit equals the total credit, so the trial balance balances.
Transposition errors Two digits are reversed (e.g., $540 recorded as $450). The trial balance may still balance if the difference is a multiple of 9.
Compensating errors Two or more errors offset each other, leaving the trial balance balanced.
Errors of principle Correct amount recorded in the wrong type of account (e.g., expense recorded as an asset).

Preparing a trial balance – worked example (correct format)

AccountDebit ($)Credit ($)
Cash8,500
Purchases3,200
Sales7,800
Creditors2,500
Capital5,000
Totals11,70015,300

The totals do not match, indicating an error. The ledger shows that Purchases were entered as $2,300 instead of $3,200. After correcting the entry the trial balance balances:

AccountDebit ($)Credit ($)
Cash8,500
Purchases3,200
Sales7,800
Creditors2,500
Capital5,000
Totals12,60012,600

Exercise – locate the error

Given the unbalanced trial balance above, list the steps you would take to find and correct the error (students answer in class).

3.2 Correction of Errors

Cambridge error types and typical correcting journal entries

Error Type (syllabus wording) Definition Typical correcting journal entry
Error of omission A complete transaction has been left out of the books. Record the missing transaction exactly as it should have been recorded (debit & credit the appropriate accounts).
Error of commission Correct accounts are used but the amount recorded is wrong. Debit the account that was understated and credit the account that was overstated for the difference.
Transposition error Two digits are reversed (e.g., $540 recorded as $450). Same as commission – adjust the two accounts by the amount of the difference.
Error of principle Transaction is recorded in the wrong type of account (e.g., capital expense recorded as revenue). Reverse the original entry and record it in the correct accounts.
Error of posting Correct amount is posted to the wrong ledger account. Debit the correct account and credit the account that was mistakenly used (or vice‑versa).
Original entry error (error in the original journal entry) Wrong account(s) or amount were used when the journal entry was first made. Reverse the original entry and re‑record it correctly.
Compensating error Two or more errors that offset each other, so the trial balance still balances. Identify each individual error and correct them separately.
Use of a suspense account Temporary account used when the trial balance does not balance. Post the difference to Suspense; later clear it when the error is identified.

When and how to use a Suspense Account

  1. Prepare the trial balance. If total debits ≠ total credits, calculate the difference.
  2. Post the difference to a Suspense account (debit if credits are higher, credit if debits are higher).
  3. Investigate the source of the imbalance – locate the omitted, transposed or mis‑posted transaction.
  4. Make the correcting journal entry.
  5. Clear the Suspense account by posting the opposite entry; the balance should return to zero.

Worked example – using a suspense account

Trial balance: total debits $23,400; total credits $22,900. Difference = $500 (debits larger).

  • Post $500 to Suspense Account – Credit $500.
  • Later we discover that a sales invoice of $500 was omitted.
    Debtors Debit $500  Sales Credit $500
  • Clear the suspense account:
    Suspense Debit $500  Suspense Credit $500 (balance returns to zero).

Effect of error correction on profit/loss, capital and the Statement of Financial Position

Error Type Effect on Profit or Loss Effect on Capital (Equity) Effect on Assets / Liabilities Period(s) Affected
Omission of a purchase on credit No effect (expense not recorded) Capital overstated (profit overstated) Liabilities understated; assets unchanged Current period and opening balances of next period
Omission of a sales revenue Profit understated Capital understated Assets (Debtors) understated; liabilities unchanged Current period and opening balances of next period
Commission error – expense overstated by $200 Profit understated by $200 Capital understated by $200 No direct effect on assets or liabilities Current period
Transposition error ($1 200 recorded as $2 100) Profit overstated by $900 Capital overstated by $900 The account that carries the amount (asset or liability) is overstated by $900 Current period
Principle error – capital expenditure recorded as revenue expense Profit understated (expense too high) Capital understated Asset (e.g., equipment) not recognised; liability unchanged Current & prior periods if not corrected
Posting error – sales recorded in purchases ledger Profit understated Capital understated Assets (Debtors) understated; liabilities unchanged Current period
Compensating error (two opposite errors) No effect on profit (errors cancel) No effect on capital Individual asset or liability balances may be wrong, but totals are correct Current period

Steps for correcting an error

  1. Identify the nature, amount and accounts involved.
  2. Determine the period(s) affected.
    • If the error relates to a prior period, adjust the opening balances of the current period (or, where required, restate the prior‑period statement).
  3. Prepare the correcting journal entry. Use the date of discovery, except for an “original entry error” where the original transaction date may be shown.
  4. Post the entry** to the ledger** and, if a suspense account was used, clear it.
  5. Update the Statement of Financial Position** so that assets = liabilities + capital.
  6. Document** the error, the analysis and the correction in the working papers for an audit trail.

Journal entry examples

1. Over‑stated expense by $150

Debit   Retained Earnings (or Capital)   $150
Credit  Expense                         $150

2. Omitted purchase on credit of $800

Debit   Purchases (or Inventory)   $800
Credit  Creditors                 $800

3. Transposition error – $1 200 recorded as $2 100 (difference $900)

If the amount was recorded as a debit to Inventory:
Debit   Inventory (correct)   $900
Credit  Inventory (incorrect) $900

3.3 Bank Reconciliation

Purpose

  • To ensure that the cash balance shown in the cash book agrees with the balance shown on the bank statement.
  • To identify items recorded by the bank but not yet by the business, and vice‑versa.

Typical reconciling items (Cambridge syllabus)

  • Deposits in transit (recorded in cash book but not yet on the bank statement).
  • Outstanding cheques (issued by the business but not yet cleared by the bank).
  • Bank charges, interest received, direct credits/debits, standing orders or direct debits.
  • Errors made by the bank.

Cash‑book adjustments before reconciliation

ItemJournal entry in cash book
Bank service charge $20 Debit Bank Charges $20 Credit Cash $20
Bank interest received $15 Debit Cash $15 Credit Interest Income $15
Direct credit from customer (e.g., $250) Debit Cash $250 Credit Debtors $250
Standing order (direct debit) $120 Debit Expense (e.g., Rent) $120 Credit Cash $120

Worked example 1 – complete reconciliation

Cash Book (as at 31 Dec)
Balance as per cash book$5,200

Bank statement balance: $4,850

  • Deposits in transit: $300 (add to bank balance)
  • Outstanding cheques: $150 (deduct from bank balance)
  • Bank service charge (recorded in cash book): $20 (deduct from cash‑book balance)

Reconciliation calculation

Bank statement balance               $4,850
+ Deposits in transit                 $300
- Outstanding cheques                $150
= Adjusted bank balance               $5,000

Cash book balance                     $5,200
- Bank service charge                 $20
= Adjusted cash‑book balance          $5,180

Difference (adjusted balances)        $180  →  investigate (e.g., a receipt not yet recorded)

Worked example 2 – includes all four reconciling items

Cash Book (as at 31 Mar)
Balance as per cash book$7,420

Bank statement balance: $7,050

  • Deposits in transit: $420 (add to bank balance)
  • Outstanding cheques: $250 (deduct from bank balance)
  • Bank interest received: $30 (add to cash‑book balance)
  • Direct credit from a customer: $180 (add to cash‑book balance)
  • Standing order (direct debit) for insurance: $90 (deduct from cash‑book balance)

Reconciliation calculation

Bank statement balance               $7,050
+ Deposits in transit                 $420
- Outstanding cheques                $250
= Adjusted bank balance               $7,220

Cash book balance                     $7,420
+ Bank interest received              $30
+ Direct credit from customer         $180
- Standing order (insurance)          $90
= Adjusted cash‑book balance          $7,540

Difference (adjusted balances)        $320  →  likely a missed receipt or a bank error; further investigation required.

Journal entries for the adjustments shown above

Bank service charge          Debit  Bank Charges   $20   Credit  Cash $20
Bank interest received       Debit  Cash          $30   Credit  Interest Income $30
Direct credit from customer  Debit  Cash          $180  Credit  Debtors $180
Standing order (insurance)   Debit  Insurance Expense $90  Credit  Cash $90

3.4 Control Accounts

What is a control account?

A control account is a summary account in the general ledger that aggregates the totals of a related subsidiary ledger. The two most common control accounts are:

  • Purchases‑ledger control account – summarises all creditors (amounts owed to suppliers).
  • Sales‑ledger control account – summarises all debtors (amounts owed by customers).

Why they are used (exam focus)

  • To keep the general ledger concise while still retaining detailed information in the subsidiary ledgers.
  • For the IGCSE exam you only need to prepare the control‑account balances; you are **not** required to reconcile them with each individual subsidiary‑ledger balance.

Elements that must appear in the control accounts (Cambridge syllabus)

  • Opening balance (creditors for purchases, debtors for sales).
  • Credit purchases and cash purchases.
  • Sales (credit) and cash sales.
  • Cash receipts from debtors / payments to creditors.
  • Cash discounts received / allowed.
  • Returns outwards (purchases) and returns inwards (sales).
  • Irrecoverable debts (bad debts) and dishonoured cheques.
  • Closing balance (creditors or debtors).

Purchases‑ledger control account – example

Purchases‑Ledger Control Account
Opening balance (creditors)$2,000 (Cr)
Credit purchases$5,600 (Dr)
Cash purchases$1,200 (Dr)
Returns outwards$300 (Cr)
Cash discounts received$50 (Cr)
Payments to suppliers$4,200 (Cr)
Irrecoverable debts (supplier default)$100 (Cr)
Closing balance (creditors)$3,150 (Cr)

Sales‑ledger control account – example

Sales‑Ledger Control Account
Opening balance (debtors)$1,800 (Dr)
Credit sales$7,200 (Cr)
Cash sales$2,500 (Dr)
Cash received from customers$5,500 (Cr)
Cash discounts allowed$70 (Dr)
Sales returns (inwards)$200 (Dr)
Irrecoverable debts (bad debts)$150 (Cr)
Dishonoured cheques$80 (Dr)
Closing balance (debtors)$1,880 (Dr)

For the exam you only need to show the control‑account format and calculate the closing balance. Detailed subsidiary‑ledger listings are optional and not examined.

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