Errors, the suspense account and the effect on profit

Last time

Before we start: last time, in Bank reconciliation statements, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

When the books are wrong

Even careful bookkeepers make mistakes. Some errors make the trial balance disagree; others hide, because both sides are still equal. This lesson covers the six errors a trial balance cannot show, the suspense account, and how errors change profit.

Six errors the trial balance does not show

These six errors leave the trial balance totals equal, so it does not reveal them.

Commission and principle

An error of commission puts the entry in the wrong account of the right type, such as Ali's account instead of Amir's. Both are customers. An error of principle puts it in the wrong type of account, such as buying a van debited to motor expenses instead of motor vehicles. Principle errors affect profit, because an asset is treated as an expense, or the reverse.

Errors that do show

Some errors make the totals disagree: a debit with no matching credit, two debits, different amounts, or an addition mistake. When the totals disagree and the error cannot be found at once, the difference is put into a suspense account. This lets the trial balance agree, so the financial statements can be drafted.

Correcting with the journal

Every correction is made through the general journal, with a debit, a credit and a narrative. First, ask what was done. Then what should have been done. The correction moves the amount from the wrong place to the right one. If the error affected the trial balance, one side of the correction is the suspense account.

Worked: an error of principle

A van costing 9,000 dollars was debited to motor expenses. It should have been debited to motor vehicles. Correction: debit motor vehicles 9,000, credit motor expenses 9,000. Before the correction, expenses were 9,000 too high, so profit was understated by 9,000, and non-current assets too low.

Worked: a one-sided error

Rent of 500 dollars was correctly credited to the bank, but not debited to the rent account at all. The trial balance credit side was 500 more, so a suspense account with a debit of 500 was opened. Correction: debit rent 500, credit suspense 500. The suspense account is now cleared.

Effect on profit

When you correct an error, ask how it changes profit. Here is the pattern.

Effect on the statement of financial position

Some corrections change an asset or a liability as well as profit, such as the van moving into non-current assets. A change in profit also changes the owner's capital, because profit is added to capital. Corrections between two expense accounts change neither total profit nor the statement of financial position.

Mistakes that lose marks

Mistake one: naming an error of commission when the type of account is wrong. That is principle. Mistake two: forgetting the narrative in a journal entry when one is required. Mistake three: getting the direction of the profit effect wrong. The fix: what was done, what should have been, then the effect.

The full-marks tip

The full-marks tip: for each error, write what was done and what should have been done, then the correcting entry. For the effect on profit, ask whether income or expenses were too high or too low.

On one card

So, on one card: errors and suspense. Keep it for revision.