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OLevel

Accounting - 7707

Verification of Accounting Records

Paper-2

Verification of Accounting Records

The trial balance and its correction of errors:

When the business prepares a trial balance, it is to check whether the ledgers are prepared appropriately or not and whether the trial balance is balancing or not. When the trial balance, balances off it is an indication that accounts are prepared properly, and there are no errors, but this is not always true because there is a possibility that there are some errors that do not affect the trial balance.

If the trial balance does not balance, it is a clear indication that there are a few errors that are affecting the trial balance. Whether an error affects trial balance or not, they need to be identified and corrected because the preparation of financial statements depends on the correct preparation of trial balance.

Errors that do not affect the trial balance:


The error of commission:

If the double entry is complete with the correct amount being involved, but the entry has been made in the wrong person's account, then it is called an error of commission.

For example, goods sold on credit worth $200 to Wasif were recorded in Asif’s account.



The example shows that the sales of 200 are recorded in Asif’s account and not in Wasif’s account, making it an error of commission.

The error of principle:

If the double entry is complete with correct amounts being involved, but the entry has been made in the wrong type of account, then it is referred to as an error of principle.

Example: Furniture bought for cash $1000 recorded as purchases.


This example shows that the entry should have been made in the furniture account and not in the purchases account.

The error of omission:

If the double-entry system is entirely omitted with no account being debited or credited, then it is called the error or omission.

Example: cash purchases $500 entirely omitted from the books.

In this case, the entry must be made in both accounts as to debiting the purchases account by $500 and crediting the cash account with $500.

Purchases DR 500

Cash          CR  500

The error of original entry:

If the double entry is complete with correct accounts being involved, but the entry has been made by the wrong amount, then it is called an error of the original entry.

Example: cash sales $600 recorded in the books at $800.


Transposition error:

If the double entry is complete with correct accounts being involved, but the entry has been made by the amount whose position of digits are in the wrong order, then it is called transposition error.

Example: cash sales $541 recorded in the books as $451.


In this error, the entry had to make with the amount of $541 but is made with $451 on both sides, offset the mistake.

Casting error:

If the double entry is complete with correct accounts being involved, but the entry has been made by the wrong amount because of the total error of invoice then it is referred to as casting error. 

Example:
 
A 500                                              
B 200
C 12O
D 240
E 610
    1750


The correct total is 1670 but the entry is made by 1750.

The error of complete reversal:

If the double entry is complete with correct accounts and correct amounts being involved, but the entry has been made on the wrong side that the account needs to be debited is credited and the account that needs to be credited is actually debited, then it is called an error of complete reversal. 

Example: cash purchases $100 debited to cash and credited to purchases.

Cash DR 100
Purchases CR 100

In this case, the entry is made on the opposite sides of the account like purchases should have been debited and cash needs to be credited to correct this entry.

Compensating error:

If two or more errors that have no relationship with each other offsets each other’s mistakes are called compensating error.

Example: cash purchases $200 

                               Purchases DR 200
                               Cash           CR 20
                  Cash sales $200       
                                Cash           DR 20
                                 Sales          CR 200

In this error, the debit total and credit total are both $220 offsetting the mistakes.

To learn these errors, there is an abbreviation of COPCROCT. 

C----Commission
O----Omission
P----Principle
C----Casting
R----Reversal
O----Original
C----Compensating
T----Transposition

Errors affecting the trial balance:

1. When the double entry is not complete, i.e., either debit entry is made, or credit entry is made but not both. 
2. Double entries are made by different amounts, i.e., the amount of debt and credit is different.
3. Both parts of double entries are made on the same side, i.e., either both accounts are debited or credited.
4. The ledger account is balanced off incorrectly.
5. The wrong amount is pasted in the trial balance.
6. A ledger amount is not recorded in the trial balance.
7. Extra accounts are written in the trial balance, an example includes closing inventory. 
8. An account is recorded on the opposite side of where it should have been recorded of the trial balance.

Whenever an error affects trial balance, it must be corrected with the help of a suspense account.

What is a suspense account?

A suspense account is a temporary account that is opened to record and correct the difference in the trial balance. Once all errors are found and corrected, the balance in the suspense account is eliminated. Until and unless all errors are rectified, we should not prepare the financial statements as their financial statements will be misleading. If we are forced to prepare financial statements even though the suspense account balance is not eliminated, then the debit balance in the suspense account balance is treated as current assets and the credit balance in the suspense account as current liabilities.

Whether error affects trial balance or not, it needs to be corrected. Errors not affecting trial balance will be corrected without involving suspense accounts.

When converting errors, we need to identify after reading the adjustments.

1. What should have been done?
2. What has been done
3. Identify the type of error
4. Correct the error.

Example:

 1. Motor vehicles bought on credit worth $700 recorded as purchases.

What should have been done: motor vehicles DR 700            What is done: Purchases DR 700

                                                       Cash                   CR  700                             Cash           CR  700

To correct our error, we should do this: Motor vehicle DR 700

                                                                       Purchases        CR 700

Errors not affecting trial balance (COPCROCT) will be corrected by making double entries without involving suspense.

Note: In some questions involving the suspense account, the opening balance is not provided nor can be found by correction or preparation of trial balance. Then, in such cases, we need to derive the suspense account balance by ourselves. In order to do so, we will find the differences in the trial balance by first making the correcting entries.

There are two types of errors affecting the trial balance:

Errors impacting the ledgers will be corrected by making double entries involving the suspense account and the concerned ledger.

Errors not impacting the ledgers will be corrected by making simple entry just by involving suspense account without involving any ledger because there is no ledger.

Example:

1. Cash sales $2000 posted in the books as $200.


Cash DR 1800
Sales CR 1800

2. Cash sales $ 2000 posted correctly in the sales account but recorded in the cash book at $200.

Cash DR 1800
Suspense CR 1800

3. Sales of $69000 posted in the trial balance as $67000

Suspense account DR 2000

4. Total receivables amounted to $21000 but posted in the trial balance as $20000.

Suspense CR 1000

Bank Reconciliation Statements:

When the business prepares a bank account because of its transactions with the bank, the bank also prepares the account of the business. When a certain amount of money is deposited into the bank, it is an asset for the business, but the same amount of money is a liability for the bank. Similarly, when an amount is overdrawn by the business, it is a liability for the business, but it is an asset for the bank. Thus, every single transaction is recorded in the ledgers of both the business as well as the bank holding the account of the business, but on the opposite sides. At the end of the accounting month when statements are being made, the balance achieved for the bank balance by the business and by the bank should always be the same. However, unfortunately, this is not usually true, and there is a discrepancy in the balances that the business and the bank holds, and hence there is a need to reconcile as to why there is a difference between the two balances.

The causes of the differences between the two are as follows:

1. Standing Order:

On the off chance that the business educates the bank to move a fixed measure of cash on a fixed date to a fixed individuals account, it is called standing order. It is quickly mulled over by the bank, however, it is recorded in the cash book once the bank statement is received at the end of the time span decided.

2. Direct Debit:

If the business instructs the bank to transfer a certain amount of money on a certain day to some person's account, the bank will record it immediately, but it will be documented in the cashbook once the bank statement is received.

3. Credit Transfer:

If someone deposits the money in the bank account of the business without informing the business, then it is immediately recorded in the bank but will be documented in the cashbook once the bank statement will be received. Also known as bank gyros.

4. Interest on Deposit:

If a certain amount of money is deposited into the bank account, then it earns an interest; these interests are the income of the business. The moment this interest is received, it is immediately recorded by the bank but will be recorded by the business once the bank statement will be received.

5. Interest in Overdraft:

If the business has overdrawn the bank account, then it has to pay interest daily until an overdraft is settled. This amount of interest on overdraft is immediately taken into consideration by the bank but will be recorded in the cash book once the bank statement will be received.

6. Bank Charges/ Service Charges:

The bank charges a certain amount of money against the services it provides to the business; these changes vary month to month depending on the services utilized. The amount of bank charges is only known to the bank and will be recorded by the business once the bank statements are received. 

7. Dishonored Cheques: 

These are those cheques that are bounced back or returned unpaid and are immediately taken into consideration by the bank but will be recorded by the business once the bank statement is received.

All the things mentioned above are those that are present in the bank statement but are not there in the cash book and hence are to be recorded in the adjusted cashbook. the following are the things that are present in the cashbook but are not there in the bank statement.

1. Uncredited Deposits:

These are the amounts that are deposited into the bank and recorded in the cashbook but are still in the process of clearing and hence are not recorded in the bank statement.

2. Unpresented Cheques:

These are the cheques issued by the business and recorded in the cashbook but are not presented to the bank for payment and hence are there in the cashbook but not in the bank statement.

All those things that are present in the cashbook but are not there in the bank statement are to be recorded in the bank reconciliation statement.

Why are cheques dishonored?

Insufficient funds in the account of the business or individual who has issued the cheque.
The signature on the cheque is not satisfied.
Amount in words and amount in figures is different
The individual who has issued the cheque died.
The individual who has issued the cheque has become mentally disabled.
The cheque is stale (a cheque becomes stale when it is more than six months old)
Overwriting on the cheque
The cheque is post-dated.
The cheque is mutilated.

The accounting treatment of questions involving bank reconciliation comprises of:

1. Adjusted cashbook
2. Bank reconciliation statement

A bank is the only thing in accounting that can either be an asset or a liability. If there is a bank balance, then it is an asset for the business and hence will be recorded on the debit end. However, if there is a bank overdraft, then it is a liability, and hence there is a credit balance.


Bank Reconciliation Statement as at (the date mentioned of the year ending):

Balance as per bank statement       xxx
Add: uncredited deposits               xxx
Less: un-presented cheques xxx
Balance as per adjusted cashbook   xxx

If the question has not given the balance as per bank statement but has given balance as per adjusted cash book and we have to calculate the balance as per bank statement, the statement will be as follows:

Balance as per Adjusted cashbook       xxx
Add: un-presented cheques                    xxx
Less: uncredited deposit                       xxx
Balance as per bank statement              xxx

When reconciling, we must ignore the following two things:

1. Any error corrected by the bank is to be ignored.
2. If the cheque number in the bank statement is older than the cheque number in the cashbook then all such entries are to be ignored.

In one variety of questions you will not be provided with the cashbook or the bank statement instead you will only be given the closing balances of the cashbook and the bank statement which obviously will be different thus creating a need to reconcile the cashbook with the bank statement. In such questions, you will also be provided with the causes of differences between the cashbook and the bank statement you have to read those differences and identify whether they are affecting cashbook or bank statement or both. If an adjustment is affecting the cashbook, it will be recorded in the adjusted cashbook, and if it is affecting the bank statement, it will be recorded in the bank reconciliation statement. Finally, the adjusted cash book balance will be equal to the bank reconciliation statement balance. In some questions, both of the statements are given and we have to compare as to what is present in the statement and what is not and then reconciling it.

The amount of bank balance present in the statement of financial position is always the adjusted cash book balance.

Note: The debit balance in the cashbook represents a positive balance, and it should be equal to the credit balance in the bank statement, which also represents a positive balance. The credit balance in the cashbook is a negative balance, which should be equal to the debit balance in the bank statement.

1. If an account is understated, then it will be corrected by making an entry on the same side by the amount of understatement.
2. If an account is overstated, it will be corrected by making an entry on the opposite side by the amount of understatement.
3. If an entry is made on the wrong side, it will be corrected by making an entry on the correct side by the double amount.
4. A bank is the only thing in accounting that can either be an asset or a liability. If there is a bank balance, then it will be a debit balance, and hence current assets, if there will be a bank overdraft, it will be a credit balance and hence current liability.
5. The amount of bank balance or bank overdraft in the statement of financial position is always the adjusted cash book balance. If the adjusted cash book balance is a debit balance, it is a current asset, and if the adjusted cash book balance is a credit balance, then it is a bank overdraft.

CONTROL ACCOUNTS:

Control accounts are divided into two categories, sales ledger control account, and purchases ledger control account.

Sales ledger control accounts: 

They are also named as revenue ledger or total receivables account. This is because it contains details of total receivables. Whatever is recorded in an individual receivables account is also recorded in the total receivables account.


Purchases ledger control account:

Purchases ledger control are also called total payable accounts as it contains details of total payables. Whatever is recorded in an individual payables account is also recorded in the total payables.


Contra setoff is always made with the minor of the two balances.
 
The source through which control accounts are prepared are the books of original entries.

The purpose of preparing control accounts are as follows:

1. To avoid errors
2. To detect frauds
3. To find credit purchases and credit sales
4. To find total receivables and total payables
5. To reconcile the control accounts with individuals accounts.

Minor balance occurs when a receivable for a very short period becomes payable or when the payable for a very short period becomes receivable.

Why does a minor balance exist?

1. Overpayment – not settled by a refund.
2. Return of goods after payment
3. Allowance for overcharge
4. Advance payment for goods to be bought later
5. Allowance for damaged goods after payment has been made

There are four important things in any control account, of which three must always be given, and fourth must be found. These are as follows:

1. Opening balances
2. Cash or bank amount (receipts or payments made depending on the title of the control account)
3. Credit sales/ Credit purchases
4. Closing balances

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