how to rectify errors in financial accounts 1223536085341285 8

8/7/2019 How to Rectify Errors in Financial Accounts 1223536085341285 8

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ST. Josephs College of

Commerce, Bangalore presents to

global students community

RECTIFICATION OF ERRORS

IN FINANCIAL ACCOUNTS

Alternative work is rest

All teachers

Who teach

Accounts

At all levels

CA-CPT

ICWA

Company secretarySit, relax and enjoy

Learn, unlearn and re-learn


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How to Rectify Errors in

Financial Accounts

By

Prof. Augustin AmaladasM.Com(Loyola college,

Chennai),AICWA., PGDFM.,B.Ed.

Simple to Tough errors and

their rectificationsUseful to CPT, ICWA,CS

Students

Useful

To lecturersWho enter

Into

Teaching

profession

Alternative work is rest by S.L.Swamy


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Dedicated to Prof.Dr. Victor Louis Anthuvan

(St. Josephs College, Trichy)

Sir made us to learn in a simple way

My guru-Thank you sir.

Dr. Abdul Kalam ex president

Studied in St. Josephs College- Trichy

Made the nation proud of.

Dedicated to Rahul Dravid SJCC, Bangalore

(Indian cricket captain)our student and my student.


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Let us under stand the basic rules,

concepts and conventions Understanding basic rules of accounting,

concepts and conventions help you to under

stand the rectification of errors better.


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1.concepts& conventions

Meaning: Basic assumptions upon which the basic

process of accounting based. a] Business entity concept-

b] Dual aspect concept

c] Going concern concept

d] Accounting period concept

e] Cost concept

f] Money measurement concept

g] Matching Concept

ConventionsCoservativism

Materiality

Consistency


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a] Business entity concept-

Business is different from the owner

We pass Journal entry when owner contributes

towards capital. When amount / goods withdrawn for personal use

we make an entry in the business

When Income tax paid by the owner out of

business money we make an entry In the books ofaccounts.


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b] Dual aspect concept

Every debit has equal amount of credit

Asset =Liability

Liability creates asset

If asset>Liability= profit

If Liability> Assets= loss


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c] Going concern concept

Business will go for at least for a reasonable

period.

Depreciation is provided based on this

assumption.

If this assumption is not made all Fixed

assets will be valued at realised value like

current assets.


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d] Accounting period concept

Fixing time limit for accounts Profit for the period

It can be one week or two week or6months/one year or5 years

But to find profit we normally consider 12months period

Financial year for income tax point of view

1st

April-31st

March of the following year Calendar year January to December

Dipavali to Dipavali


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e] Cost concept

The cost to the organisation (Actual) isrecorded in the books

Assets are not recorded according to the

market price every year. Depreciation is calculated on cost not based

on market price

Accounting records may not show the realworth of the business

Market price may be disclosed with in

bracket in the balance sheet


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f] Money measurement concept

Every thing which can be expressed in termsof Money is recorded in the books

Beautiful women are working /Handsome

boys working in TEC /Efficient engineersworth Rs.5000 crores How do you record?.

Good working environment?

Highly motivated employees? Qualitative information are not accounted.


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Answer

We do not have record for qualitativeaspects. They can enter this transaction

underHuman resource accounting ratherthan financial accounting.


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g] Matching Concept

Matching Cost with revenue

It is used to estimate correct profits

Accrual/ cash basis of accounting Even cash paid /received if it belongs to accounting

period we consider them as expenditure /income

Salary outstanding for the last month?

Income from Investments yet to be received? Rent received in advance for next year?

Salary outstanding for the last month to be consideredas expense of the current year under accrual basis ofaccounting.


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Matching concept- continues Income from investment yet to be received to be

considered for the current year as it belongs to

current year.The year of receipt is not important. Rent received in advance does not belong to

current year under accrual method of accounting

as it belongs to next year even though it is

received during the current accounting year.


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Conventions

Customs and traditions that are followed by the

accountants while preparing the financial

statements. Why do we respect elders?

Why do we shake hands?

Why do Young Indians hate receiving dowry? Why do students come late to class?

Why do Indians work hard?


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Coservativism

To be on the safer side

Expect future losses as current year loss

But future income is not treated as currentyear income.

Stock is valued cost price / market price

which ever is lower Making provision for bad debts is based on

this assumptions.


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Materiality

Material impact on profitability areconsidered

Insignificant transactions ignored fromrecording

Pen purchased, pencil purchased?

It comes under stationary. It can not bedisclosed(Shown) separately like penaccount or pencil account.


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Consistency Accounting policies and procedures should

be followed consistently

Method of depreciation should be followedconsistently.

Stock valuation- cost/market price

whichever is lower is consistently followed If not followed it amounts to change in the

policy of the company


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2.system of accounting

(26)

1.Cash system:

unless cash received /paid in theaccounting year can not be

considered as income/expensesrespectively


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2.Mercantile

Mercantile/Accrual/due concept: Even cash received/paid but due for payment/due for

receipt (yet to be received/payable) if they belong tocurrent accounting year are considered.

If last year expenditure paid this year?

If you receive/paid in advance ?

If last year expense paid during the current year can not beconsidered as current year expenditure.In the same wayany income received in advance at the end of current yearshould not be entered as current year income orexpenditure.


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1

3. es f e it re

A) Ca ital e e it re

B) Reve e e e it re

C) Deferre Reve e

e e it re


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A) Capital expenditure(30)

Expenditure incurred which will :a) Increase Production capacity

b) Increase earning capacity

c) Reduction in the cost of operation.

Example: purchase of fixed assetsPurchase of Machinery

purchase of investment

If such expenditure is not to do with the basic functions of

the business such expenditure is capital expenditure.How do you consider if you buy goodwill, copy right or

patent right?


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Capital expenditure-continue(page-30)Both tangible and intangible assets included

Intangible assets such as patent right, copy right, technical

know-how, franchises, goodwill etc.,Depreciation is provided on fixed assets. Depreciation

appears in the profit and loss account

The asset appears in the Balance sheet (after deducting

depreciation)

The life is more than one year

They should not appear in the profit and loss account


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Revenue Expenditure

Expenditure incurred which will :

a)Not Increase Production capacity

b)Not Increase earning capacity

c)maintain the capacity

No Depreciation is provided on current assetswhich will appear in the profit and lossaccount

They appear in the profit and loss account

The life is not more than one year

They should not appear in the balance sheet


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Wrong treatment? When goods purchased(dealer in such

goods) it is a revenue expenditure. It should

appear either in the trading account or profitand loss account.

If it appears as an asset , then you inflate the

profits which gives a wrong profit to thefirm.It also affects the assets(over stated)

which gives over stated financial position.


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Example:

Your father purchased 20 kg rice bag costing Rs.600

and your mother purchased a fridge for Rs. 15000 onthe same day.Rise is to be treated as monthly

expenditure where as fridge to be treated as long term

expenditure(Capital expenditure).

Instead, if such purchase of rice accounted withfridge it means monthly expenditure decreased and

long term expenditure is increased.

Accounting point of view rice goes to trading account

to find out cost of the month and fridge goes to

Balance Sheet on the asset side as a part of asset.


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Suppose fridge cost is added with rice, then your

monthly expenditure will be high and asset

account is reduced. The indirect impact is that depreciation would not

have been provided on such asset as it is included

with revenue(Rise)account which affects profits.

Example-2:

Building purchased for Rs.20,00,000 entered into

purchase account.Building depreciates by 10%

under straight line method.


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Here it is entered into purchase account. It means you

are treating it as goods(dealer in real estate) which is a

revenue expenditure instead of capitalexpenditure.Your profit is less by Rs. 20,00,000. But

had been entered into building account the profit would

have been more by Rs.20,00,000.

Because it is entered in the purchase account we hadforgotten to provide depreciation of Rs.2,00,000 which

should had been done.

Net effect to rectify the error is:- Increase the profits by

Rs.18,00,000. And increase the asset should be

increased by 18,00,000.


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Suppose you are a dealer in

building(Real estate) Purchase of building is considered as goods(dealer

in building).The entry made in purchase account is

correct. No need to rectify such transaction.

Suppose you buy furniture(dealer) for Rs.20000

entered into furniture account.What is the effect?

How do you rectify?


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Here the mistake is that revenue expenditure is

treated as capital expenditure.The correct

journal entry is Purchase a/c debit and cash a/ccredit.

Wrong entry is: Furniture a/c debit and cash

is credited. In the absence of information we assume the

mistake with respect to furniture and purchase

but there is no mistake with respect to cashaccount because cash payment is correct.


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Deferred revenue

expenditure(page-30) Deferred means- postponed

Heavy revenue expenditure

Vodafone incurred 200 crores for advertisement aftermerger with Hutch

It can not be written off within a year

It appears in the balance sheet as last item

Every year some amount is written off in the profit and loss

account. Research and development expenditure, initial

advertisement expenditure, preliminary expenditure areexample


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5.Double entry / Single entry

Is Accounting based on business concept or

religious concept?

Giving first and receiving later.

Giving cash receiving machinery

We consider both aspects such as debit and

credit


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Rules of accounting

Personal rule/Account-supplier debtors,owner, banker, outstanding wages

Real rule/Account- cash, bank, building,furniture, goodwill, patent rights

Nominal rule/account: income and

expenditure: salary, rent , insurance,commission, internet expenses, cell phoneexpenses.


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Personal rule

Debit the receiver

credit the giver Example: Computer chips purchased on credit

from wipro

Here credit Wipro as Wipro is the giver of

computer. Sold goods to Meena

Meena is the receiver-debit


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Exercise

Amount collected from debtors? Amount deposited to bank?

Amount collected from debtor: Cash and debtor are

important.Cash is related to real rule

Debit what comes in and credit what goes out

Therefore cash to be debited and debtors belong to

personal rule.Credit the giver. Therefore credit debtor

account. Cash deposited to bank : JE: Bank a/c debit and cash to

be credited.


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Real rule These are the accounts of assets and liabilities

Rule: debit what comes in Credit what goes out


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Nomi al r le

Related to Expe ses a d i come

R le: Debit all expe ses a dlosses

Credit all i comes a d

gai s


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Suitable questions to pass journal

entry If cash transaction, person is not important

Every birth of an account there is a death of

the account

Ask what comes in?

Or what goes out?


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Let us pass Correct Journal entries

for a few transactions

General rules:- All assets are debited if it comes tobusiness(when you buy for business)

All liabilities are credited when borrowed.

All expenses are debited and All income and gains are

credited.If it is a credit transaction person is important. If it is a

cash transaction person is not important.(like cashpurchase or cash sales)


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Pass Journal entries

1. Capital introduced by owner Rs. 20lakhs.

Answer: Business point of view owner is different

from business. Business receives cash andthe giver is owner.

JE: Cash a/c debit(Real rule)

Capital a/c credit(Personal rule)


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2

. Borrowed loan Rs. 10,00,000

Answer:

Cash comes to business and loan vendor

account is important.

JE: Cash a/c debit(Real rule)

Loan a/c credit(Personal rule)


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3

. Company issues Shares to public

Rs.50,00,000.

Answer:

Cash comes to business. Many owners

given this money.

JE: Cash a/c debit (Real rule)

Share capital a/c credit(Personal rule)

4


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4. Partners contributed capital to business: A Rs.55,00,000 cash and

B Rs.19,00,000 in cash, building worth Rs.50,00,000, furniture

worth Rs.25,00,000 and his good will Rs.10,00,000. Answer:

JE: 1.Cash a/c debit Rs.55,00,000(Real rule)

As Capital a/c credit Rs. 55,00,000

(personal rule)2. Cash a/c debit Rs.19,00,000(Real rule)

Building a/c debit Rs. 50,00,000(Real rule)

Furniture a/c debit Rs. 25,00,000(Real rule)

Good will a/c debit Rs. 10,00,000(Real rule)Bs Capital credit Rs.104,00,000

(Personal Rule)

Here cash, building, furniture and good will are assets coming tobusiness therefore debited.The giver is B therefore credited.


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Share broker purchased shares Rs. 25,00,000.

Answer:

Shares are coming to business. First understand the

nature of business. Being a share broker shares

are considered as goods(a revenue expenditure).Goods are purchased for cash.

JE: Purchase of goods a/c debit Rs.25,00,000

(Real rule)Cash a/c credit Rs.25,00,000

(Real rule)

5


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Infosys buy shares of Wipro Rs.20,00,000 for

cash.

Answer:

Here Infosys is not a dealer in shares. It is a

capital expenditure. It is not goods. It is a cash

transaction.

JE: Investments a/c debit Rs.20,00,000(Real rule)

Cash(Bank) a/c credit Rs.20,00,000

(Real rule)

6.


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Debentures issued by ICICI Bank for Rs.1

crore.

Answer:

ICICI point of view, it is a loan.Cash collected.

JE: Cash a/c debit Rs.1 crore(Real rule)

Debenture a/c credit rs. 1 crore

(personal rule)

7.


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Building acquired by Wipro by issue of shares

Rs.20,00,00,000.

Answer:

It is a capital expenditure.Here no cash paid but given

shares.The person who supplied shares are share

holders(owners)

JE: Building a/c debit Rs. 20 crores(Real rule)

Share capital a/c Rs.20 crores(personal rule)

Note: share capital does not come under real rule butshare capital belongs to person who owns them.

8


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Shares of Wipro limited held by Infosys sold forRs.25,00,000.

Answer:

The investments sold; the capital receipt. When ever we

use the term sales account it indicates the goods thatthe company deal.

JE: Cash a/c debit Rs.25,00,000(real rule )

Investments a/c credit Rs. 20,00,000

(Real rule)

Profit on sale of investment a/c credit Rs.5,00,000

(Nominal rule)

9


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Salary paid to Kumaran Rs.50,000

Answer:Salary paid for services rendered by Kumaran.Kumaran

is not a creditor. Salary is an expenditure.

JE: Salary a/c debit 50,000

Cash a/c credit Rs.50,000If we enter into Kumeran account by using personal rule,

kumeran account were to be opened.How do you closehis account? Salary is important rater than Kumeran.If

you cannot close any time during the life of thecompany do not open such account. In the same wayrent paid to land lord can not be entered into land lordaccount.Instead it should be entered in the rent

account.

10


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Depreciation provided on Plant and Machinery

Rs.2,00,000.

Answer:

Depreciation is a non cash account. There are manytransactions are non cash items. It is an expenditure asthere is a reduction in the value of asset.

JE: Depreciation a/c Debit Rs.2,00,000(Nominal)

Plant and Machinery a/c Rs.2,00,000

(Real rule)-goes outNote: Plant and Machinery account goes out year after

year when we provide depreciation. The capitalexpenditure slowly becomes a revenue expenditurewhen we provide depreciation.

11


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Company declared dividend Rs. 20,00,000

Answer:

Dividend is an appropriation of profit.It is not an

expenditure because it is a share of profits.In order

to compute profit we do not reduce dividend.

JE: Dividend a/c debit Rs. 20,00,000(Nominal rule)

Cash a/c credit Rs.20,00,000(Real rule)

12


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Interest paid on debentures/loan Rs. 1,00,000

Answer:

Interest is a business expenditure as it is paid to

third party. If paid to owner is not considered as

expenditure.

JE: Interest a/c debit Rs.1,00,000(Nominal rule)

Cash a/c credit Rs. 1,00,000(Real)

13

www augustin co nr


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Rectification of Errors

Before preparing

Trial Balance

After trial balance

But before Trading,

P/L and Balance sheet

After preparingTrading and P/L

and Balance sheet

Hit the individual

account

Hit profit or reserve or

Capital{do not bother

about individual/nature Of expenditure}

And hit the Balance sheet Only net balance

if it affects Balance sheet

www.augustin.co.nr


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Basic rules for rectification-1

If words used account-means error only withrespect to that individual account.

Example: wages paid Rs50,000 not entered intowages account.

Here wages paid might have affected cash also, butthe statement says that it is not entered into wagesaccount only. It does not mention about cashaccount. Therefore we assume that cash accounthad been entered correctly.Therefore rectify wagesaccount only. It is one side error or one accounterror.


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Basic rules for rectification-2

Do not make too many assumptions.

Example: wages paid to install a machinery is

entered into wages account.Here you find wages account is treated as a revenue

expenditure(Refer to the notes earlier) but it is acapital expenditure. Any expenditure incurredbefore the asset is put into use to be capitalised .What about cash account?

We assume that cash account would have beencorrectly entered. (Continue in the next slide)


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You might ask which side of wage account hadbeen entered, whether debit or credit?

Normal assumption is that wages alwaysentered in the debit side(nominal rule).

Do not assume, had been entered into credit sideof wages account what would have happened-

It is unnecessary assumption(too much in yourassumption)

Ask question:whether one/ two accounts is/are

affected?H

ere wages (wrongly entered) butyou should enter in the Building account now.

This is a normal assumption.


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How do you rectify wages?

Building account to be debited Rs.50,000

Wages account to be credited Rs.50000

To remove wages from the account put it in theopposite side of that account.

Every account is born in one side ie debit orcredit.All assets and expenditure accounts are born

in the debit side. If you want to kill it put it on thecredit side.

In the same way liabilities and income accounts areborn in the credit side. If you want to kill it put it on

the debit side.


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Rectification rule-3

Error to be rectified before the preparation of trial

balance or after trial balance or after the

preparation of Balance sheet. Before preparation of Balance sheet-Hit the

individual account

After preparation on trading, profit and loss

account and Balance sheet- reduce/increase profitif it is an expense and if it affects asset/liability

increase/decrease the net amount only.


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Rectification of errors-Rule-4

If one side error(one account) to fulfill the double

entry book keeping we open suspense accountprovided, trial balance is already prepared.

Example:- Salary paid to Ranganath not entered intosalary account by Rs. 40,000

The mistake is only in salary debit side because salaryappears on the debit side. Cash account is correct(donot assume too much as I have stated earlier).

Rectification entry:

Salary a/c debit Rs.40,000

Suspense a/c credit Rs. 40,000.


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Example for suspense account

Trial balance: Debit credit Purchases 5000 -

Wages 3000 -

Sales - 10,000

Building 4000

Suspense account ??? 2000(CR)

ote: here suspense account is a credit balance as trial is not an account

Since debit side of trial balance is more

than credit side, suspense account

is not a credit balance


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Omitted from book(s )meansboth debit and credit of such

transactions are omitted.Account means omitted to enter into that specific

account only(normally one side error)

Example: purchases from Mr.Amal not entered in the

purchase books Rs. 50,000Here this transaction is completely omitted as it is given

the word books.

To rectify pass a fresh journal entry:

JE: debit purchase a/c Rs.50,000

Credit Mr.Amal a/c Rs.50,000

Suppose it is stated that not entered into the purchaseaccount how do you rectify?

Rectification of error-Rule-6


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Here, the mistake is only in the purchase account. There

is no mistake in Mr. Amals account

Rectified entry is:

Purchase a/c debit Rs.50,000(real rule)

Suspense a/c credit Rs.50,000

(fulfill double entry)

Note: normal assumption is that purchase is always

debit.If it is sales it is always credit.63

Exercise-1


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Rupees 1000 spent for repairs of building has been

posted to building account.

Identify the mistake:

1. Repairs 2. Building.

Repairs do not increase the capacity of building but tomaintain the building. Therefore it is a revenue

expenditure but treated as capital expenditure.

Rectification : add to repairs and remove from building

Rectification entry: repairs a/c debit Rs.1000(real rule)

Building a/c credit Rs.1000

(to remove from building a/c)

Exercise 1


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Sale of furniture Rs.20,000 entered in the Sales

account.Here he is not a furniture dealer. There fore sale of

capital asset brings capital receipts. It is treated asrevenue receipts( like dealing in goods of furniture).

Rectification entry:Sales a/c debit Rs.20,000

(to remove from sale)

Furniture a/c Rs.20,000

(to reduce furniture)

Note: sales normally credit and furniture is normallydebit as asset.In order to kill put it in the oppositeside.

Exercise-2


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A sale of Rs.2000 to Min Min was credited to Min Min

account.Here the error with respect to Min Min account only.we

assume that sales a/c is correct(normal assumption as Ihave explained earlier)

The normal Journal entry is :MinMin a/c debit and Sales a/c credit.

But we have credited Min Min a/c instead of debit.Torectify such error double the amount and put on the

opposite sideRectification entry: Min Min a/c debit Rs.4000

(one 2000 for rectification and another to make actualentry

To suspense a/c credit Rs.4000

Exercise-3

E i 4


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A purchase of Rs.6700 had been posted on the debit

side of the creditors account as Rs.7600Here mistake with respect to creditor only on the wrong

side as creditors normally appear on credit side(allliabilities appear on the credit side).

The second mistake is amount.Method of rectification: Remove the wrong amount and

post the correct amount on the correct side.

Rectification entry: Suspense a/c debit Rs.14,300

creditors a/c credit Rs.14,300(Rs. 7,600 is to remove wrong and Rs.6,700 to post

correctly and suspense account is opened to fulfilldouble entry as it is a one side error)

Exercise-4


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A sale of Rs.10,000 to Mr.Tim had been passedthrough the purchase day book.

Here the mistake is misunderstanding oftransaction.Instead on sale treated as

purchase.The book means complete omission. Rectification method: reverse sales and Tim to

remove the mistake and post the correct onceagain.

Rectification entry: 1. Tim A/c debit Rs.10,000

Purchase a/c credit Rs.10,000

(to remove the mistake put in the opposite side)

Exercise-5


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2.To post the correct entry:

Tim a/c debit Rs. 10000

credit sales a/c Rs.10,000

Instead of passing two entries we can combine both

the entries like this:

Debit Tim a/c Rs.2

0,000Credit purchases a/c Rs.10,000

credit Sales a/c Rs.10,000

Exercise-5 continues

E i 6


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Goods sold on Higher Purchase Rs.50,000 entered in

the sales account after the payment of first

installment.

Here there is a technical error. The ownership is

transferred only after the last installment. In order torectify remove from sale to the extent of sale price

and add to stock to the extent of cost. Assume cost is

Rs. 40,000.remove from debtors Rs.50,000

Rectification entry: Sales a/c debit Rs. 50,000Stock a/c debit Rs.40,000

To Debtors a/c Credit Rs.50,000

(To remove sales, debtors and added to stock)

Exercise-6


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Rectification after the preparation oft Trading and Profit and loss

account and Balance Sheet(after preparation of final books or

financial statements)

Major repairs to renew the building Rs. 3,00,000 entered in the

repairs account.

Rectification: repairs appear in the Profit and Loss account and

building appears in the Balance sheetTo Rectify: Increase profit by Rs. 3,00,000 and add to building by

Rs.3,00,000 in the balance sheet

JE: Building a/c debit Rs. 3,00,000

Profit and Loss a/c credit Rs. 3,00,000

Assumtion: renewal done at the end of the year.Nature of

expenditure is not important to rectify after the preparation of

final account.

Exercise-7

E i 8


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Building purchase Rs. 40,00,000 entered in the

Furniture a/c as Rs. 20,00,000. Depreciation onbuilding is 10%.Depreciation on Furniture is30%.(Rectify after final accounts prepared)

Both building and furniture fall in the balance sheet.

But depreciation rates differ. It affects profittoo.Depreciation on building is Rs.4,00,000 anddepreciation on furniture is Rs.6,00,000.we hadprovided excess depreciation during the year,

therefore profit should be increased. Furniture in the balance sheet to be reduced by

Rs.14,00,000 and building to be increased by36,00,000. ??? What is the rectification entry.

Exercise-8


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Thank you very much

Help your father in cooking

Help your mother

If you want to take rest

Sweep your room

Alternative

Work is rest


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Rectification entry?

Building a/c Debit Rs.36,00,000

Furniture a/c credit Rs.14,00,000

Profit and loss a/c Rs.2,00,000

Suspense account credit Rs.20,00,000

Note: Show net amount only.

how to rectify errors in financial accounts 1223536085341285 8

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