In the month of August, the books of Thematic Co. ltd disclosed some accounting standoffs for the trial balance did not add up. The statement portrayed a debit difference of $69,120
You were asked to interrogate the books of account of this organization and after inspection of the ledgers, the following errors where discovered.
(i) Some debtors with an aggregate debit balance of $3,915 was by mistake ignored and was not included in the debtor schedule totals which was posted in the trial balance.
(ii) Some furniture which had cost 54,000 was by mistake recorded in the furniture repair expense account.
(iii)The cashbook debit entry was understated by $32,400 and had not been rectified since then.
(iv)Sales daybook had been overstated by $16,200. This amount was the total value of credit sales made in a certain week of the month.
(v)Your Co. ltd wrongly recorded an incoming debit note of $8,055 on the opposite side of the respective supplier’s account.
(vi)Your Co ltd received water bill from the service provider and no action to pay had been undertaken hence an accrual at the moment. The amount due was $6,840.
(vii)A debtor with a bad history of payment had his account of $32,895 subjected to provision for doubtful debt. He managed to pay by check at last and his account was closed. However, this entry was not captured in the cashbook as supposedly.
Required
1. Show the financial implications/position before the corrections were done on 31/1/2019
2. Show the corrections and the final financial position after the error was corrected
SOLUTION!
Step one involves identification of the origin of the error. In other words, one has to trace at what point the error occurred. For instance, is it at the point of recording the transaction in the respective source document or at the point of posting the information to the ledger account. After that, step two, you classify or assess the type of error that has occurred strategize how to correct the error for they have different ways of rectifying. Then in step three, you go ahead and assess the nature of effect the error has caused on the identified item, that is if it caused an increasing or a decreasing effect.
The next step four involves preparation of the respective affected ledger accounts to first of all show the financial status of such accounting items before doing the actual corrections using journal entries as guided in step five.
Here we go!!
STEP FOUR; Extract the respective affected ledger account(s)
Interpretation to the entrepreneur/learner;
For the entrepreneur to have full understanding of how and why the corrections were done, let us consider each case given and interpret it so as to give a justification for such adjustments
In question two, unlike in the previous question one, the case is of a debit balance. The question to ask ourselves is, why debit balance and what could have caused such an entry? The answer is similar to that of question one and therefore we will not re-visit that. In this question and those others which will be looked in to will have similar opinion. Now, with that in mind, let us further interpret the error issues raised.
The first one is;
(i) Some debtors with an aggregate debit balance of $3,915 was by mistake ignored and was not included in the debtor totals posted in the trial balance.
This is an error of omission whereby the amount stated of some of the debtors were not included in the debtors’ schedule and this means the remedy is to add the figure in the debtor account by making a debit entry. Of course the corresponding entry is to eliminate the suspense account by undertaking a credit entry.
(ii)Some furniture which had cost 54,000 was by mistake recorded in the furniture repair expense account.
This is error of principle for the wrong entry was in a different class of account to the one to be updated. That is, furniture account is in real account class (i.e non-current account) whereas furniture repair account is a nominal account (i.e operating expense account). Therefore, a direct reverse entry is made to correct the error and this implies that suspense account is not considered.
It should be noted that this error affected the net profit of the year in a negative way for it caused a decreasing effect. To correct this error in the P&L account, the amount has to be added back.
(iii)The cashbook debit entry was understated by $32,400 and had not been rectified since then.
Understated cashbook value is a computation problem and to correct it, an additional amount in shortage has to be debited in the cashbook and this implies that we reduce the amount of debit entry in the suspense account by making a credit entry in the corresponding account (ie the suspense account).
(iv)Sales daybook had been overstated by $16,200. This amount was the total value of credit sales made in a certain week of the month.
In case (iv), the error was committed at the point of books of original entry/prime book. If you can remember in level two, we discussed the format of books of original entry. For instance, in this case of sales daybook, the individual debtor debit totals are usually recorded separately in this document and at last the aggregate total of all the debtors in that page are indicated at the bottom. In this case, correct entry for individual debtors in the sales day book was correctly made but the overall totals were overstated. This implies that posting of individual debtor balances brought down was correctly done in the respective debtor/accounts receivable accounts in the general ledger but for sales totals was wrong. To demonstrate how this error occurred, look at this sales day book
So you see, that the individual entries for debtor let say one up to five was correctly entered in this document. But the totals was indicated as XX+16,200 whereby the $16,200 is an excess that need to be eliminated. To solve that problem, sales account is debited with a corresponding credit entry in the suspense account. By doing so, the sales account is adjusted downwards to the correct balance.
It should be noted that this error affected the net profit of the year in a positive manner for it caused an increasing effect. To correct this error in the P&L account, the amount has to be deducted.
(v)Your Co. ltd wrongly recorded an incoming credit note of $8,055 on the opposite side of the respective supplier’s account.
An incoming credit note is a book of original entry prepared by the supplier to the buyer of goods (in our case the buyer here is Your co ltd) to correct an undercharge of the incoming invoice. An incoming credit note is also referred to as an additional invoice.
The credit note arises when the supplier notices that the total charges indicated in the invoice which has already been sent to the buyer is understated. Therefore, the credit note is meant to add the creditor’s (i.e supplier’s amount) as per the books of the customer (i.e the buyer who in our case is Your co. ltd). So this adjustment requires making a credit entry on the creditors account. In the current situation, the $8,055 was debited in that account hence causing a decline of the total creditors balance brought down. To correct this error, a double amount (i.e 16,110 (8055*2)) is credited. The reason being to first clear the error and then do the correct entry as it ought to be. A corresponding debit entry in the suspense account is passed.
(vi)Your Co ltd received water bill from the service provider and no action to pay had been undertaken hence an accrual at the moment. The amount due was $6,840.
This error implies that there was complete omission of this entry (i.e error of omission). To correct it, a debit entry is supposed to be made in the water expense account and a corresponding credit entry in the water accrual account for the amount was not yet paid by this time.
It should be noted that this error affected the net profit of the year in a positive way for it caused an increasing effect. To correct this error in the P&L account, the amount was subtracted.
(vii)A debtor with a bad history of payment had his account of $32,895 subjected to provision for doubtful debt. He managed to pay by check at last and his account was closed. However, this entry was not captured in the cashbook as supposedly.
In this case, the specific debtor account was closed down, meaning that after paying the debt using check, the specific debtor account was credited to clear that account. This further implies that the provision for doubtful debt which was made up of this figure was closed down. The only problem that occurred is that no corresponding debit entry that was made on the side of the cashbook. This is an error of single entry. Therefore, the corrective measure is to debit the cashbook with a corresponding credit entry in the suspense account. Having interpreted the error implications, we go to the next step of journal entries;
Step five entails journal entries to initiate the process of correcting the errors as follows;
Journal entries
