Adjusting entries are journal entry that adjusts the balance of certain accounts to show the correct balance in the financial statements at the end of a specified period. Adjusting entries are usually made at the end of the month, quarter, or year, to ensure accurate accounting of income and expenses.
The main objective of adjusting entry is to follow the accrual basis of accounting in recognition of income and expenses. In this, the financial statements reflect the actual position and financial activities correctly.
Journal entries are made as soon as business transactions take place. Then transfer to ledger, preparation of trial balance and finally final account. At every level of this work, mistakes can happen and, these mistakes can lead to a wrong financial statement. Errors may occur due to carelessness of accountants or lack of adequate knowledge of accounting principles. All the errors need to be corrected before the final account. Sometimes the trial balance does not match due to the mistakes of the wrong debit-credit entry, and even if the trial balance matches, some mistakes may remain. Therefore, all errors should be identified and corrected before final accounts are prepared to reflect the true picture of the business. Thus, determining the correct condition of the business is one of the functions of accounting.
However, if a mistake is found, it is not the principle of accountancy to cut and delete it. For this, one or more journal entries are required which are called adjusting entries. Final accounts have to be started after clearing the errors.
Classification of Errors
There are many mistakes that are found at the time of entry. Also need to mentioned that, some mistakes which are not easy to find out even with trail balance. The errors can be detected only if there is sufficient knowledge of accounting record keeping. Accounting errors can generally be divided into 2 categories.
1) Error of Principal and 2) Clerical Error.
There are 3 types of clerical errors
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- Error of omission
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- Error of commission
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- Compensating error
Mainly 4 types of errors found in accounting, but any of them involves one or more accounting areas; As a result, correction journal entry is required for all wrong sectors.
1. Errors of Principle:- In business transaction some income and expenditures of are revenue type and some income and expenditures are capital type. Accountant need to understand the nature of the transaction.
Visit here to know about Revenue and Capital Expenditure
2. Clerical Mistakes:- Mistakes made while recording transactions are called clerical mistakes. This error is mainly related to data entry. The types of this mistake are discussed below:
a) Error of Omission: If a transaction is not recorded in the books of account is called error of omission. This has no effect on trial balance but the calculation remains incorrect.
For example, $10,000 of goods were purchased on credit but no entry was made in the purchase ledger and no entry was made as a creditor.
b) Error of Commission: It is basically a mistake regarding writing the wrong amounts. That is, the error in writing the amount at the time of entry in the book of account is called error of commission. This can be in the case of wrong amount, addition, subtraction etc.
For example, the purchase account is supposed to be $50,000 debit but the amount is initially written as $5,000. Again, there may be error in addition and subtraction during balancing. These all are error of commission.
c) Compensating Error: It is an incidental error which is difficult to detect. That is, when an error is compensated by the occurrence of another error, it is called a compensating error. This will not adversely affect the trial balance but the accounting error will remain.
Example: $32,000 was debited instead of $23,000 as purchases. Again, $43,000 was credited instead of $34,000 as sales. Here the debit credit matches, but the $9,000 error remains in both cases.
Rectification of Errors
Debit Credit Mistake: One side of a transaction is correctly accounted for and the other side is not. This error is detected while preparing the trial balance.
From error of principal to the error of omission, the error of commission, the compensating error, all documents should be checked thoroughly. It is not possible to find out such mistakes without checking the accounting documents.
Adjusting the Errors:
Due to error of omission, no transaction entry is found, so it has to be solved with the entry of that transaction.
In case of other Errors: A reverse entry must be made for each error after the error is identified. According to the rules of accounting, if there is a mistake, there is no scope to remove it, rather reverse entry is the solution.
Example:
$32,000 was debited instead of $23,000 as a purchase. Again, $34,000 was credited instead of $43,000 as a sale. Here the debit credit matches, but in both cases the $9,000 is left in error. Both cases the balance has gone up by $9,000, now here are two reverse entries to get it in the right balance.
Reverse entry: for purchase.
Cash…………………………………………… $9,000 Dr.
Purchase………………………………………………… $9,000 Cr
Reverse entry: For sales.
Sales…………………………..……………… $9,000 Dr
Cash………………………………….……………………… $9,000 Cr
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