“Making good judgments when one has complete data, facts, and knowledge is not leadership – it’s bookkeeping” — Dee Hock.
Accounting is the backbone of how enterprise accounting teams capture and report financial transactions. Accountants analyze debit and credit entries at the end of every accounting period to determine their organizations’ financial position. Accounting errors arise as they make unintentional mistakes during the accounting process.
Accounting mistakes may not be noticeable to untrained eyes, but they significantly impact an organization’s financial statements. CFOs presenting these numbers publicly or in board meetings may mislead investors and stakeholders. Even a transposed digit can raise questions about a company’s financial credibility.
Learn the common types of accounting errors along with how to detect and prevent them in this article.
What are accounting errors?
Accounting errors result from inaccuracies and accidental mistakes while recording journal entries, matching them, or preparing financial reports. Transposing numbers, misunderstanding accounting rules, and hitting incorrect keys are the main reasons behind these errors.
Unlike an accounting fraud, an accounting error is unintentional and doesn’t aim to change or hide accounting records for a company’s benefit. However, these errors can have significant consequences on business decision-making.
A recent Financial Executives International (FEI) study shows that 90% of US-based organizations consider transparent financial reporting necessary to enhance investor confidence and corporate governance.
Understanding accounting errors
Organizations don’t commit accounting errors or bookkeeping mistakes to avoid taxes or not comply with regulatory guidelines. These errors are unintentional but can be costly. For example, enterprises may experience financial complications or not have an accurate picture of their financial health because of incorrect statements. That’s why organizations strive to identify and correct errors before making final reports.
Accountants use trial balance worksheets to record and match debit and credit transactions. These worksheets ease how they find the incorrect entries when both accounts don’t match. Later, they carry over the trial balance to financial statements and balance sheets at the end of an accounting period. Identifying errors becomes tricky for accountants when the trial balance remains balanced despite accounting errors.
Importance of correcting accounting errors
Incorrect accounting data makes it difficult for organizations to analyze cash flow and make informed decisions. Moreover, inaccurate financial statements impact an organization’s relationship with suppliers, investors, and customers. That’s why enterprises must pay attention to correcting accounting mistakes.
- Data-driven decision-making: CFOs and C-suite executives rely on critical financial metrics to evaluate organizations’ liquidity, profitability, and economic health. Incorrect accounting data leads to misinformed decisions, which hinders strategic business growth.
- Credibility: Organizations sharing error-free financial information gain trust and establish credibility among customers, stakeholders, suppliers, lenders, and customers. They also advance the confidence of investors, which is vital to attracting potential investment opportunities.
- Regulatory compliance: Presenting accurate financial data is critical for meeting regulatory standards and accounting guidelines. Companies filing inaccurate reports may face legal penalties.
- Tax and audits: Accounting errors create a domino effect, resulting in incorrect tax calculations and financial losses. Moreover, inaccurate accounting entries make financial audits lengthier and costlier.
- Budgeting and financial planning: Companies need more accurate accounting data to prepare accurate forecasts. As a result, businesses may create inaccurate projections, misallocate resources, and face challenges.
Types of accounting errors
Check out the common accounting errors and how they impact an organization’s finances.
1. Error of original entry
An error in the original entry is a data entry error. It happens when businesses post the wrong amount for one or more transactions to one of their accounts. This wrong amount is reflected in other accounts for specific transactions. As a result, accounts remain in balance but for incorrect amounts.
Error of original entry example
Incorrect numbers, digits in the wrong order, and words instead of numbers are examples of original entry error.
Organizations usually recognize this error from incorrect trial balances or reconciliation statements. The best way to prevent this mistake is to double-check entries and use accounting software for automating transaction recording.
2. Error of duplication
An error of duplication occurs when accounts enter the same accounting entry twice. Duplication errors also happen when accountants enter the cost of goods sold (COGS) twice or duplicate paychecks.
Duplication error example
For example, an income credited twice in the income statement or an expense debited twice will cause an error of duplication.
Consider matching bank statements with records to find duplicate entries.
3. Error of omission
A false negative or an omission error occurs when accountants don’t record an entry even after the completion of the transaction. This error happens when you forget to enter a sale or purchase transaction in the books of accounts.
Omission error example
Forgetting to add bills payable amounts for vendor supplies is a typical example of error of omission. This mistake can also happen when companies forget to recognize revenue from account receivables.
Consider looking for trial balance discrepancies and double-checking entries to avoid this error.
4. Error of entry reversal
An entry reversal error happens because of posting credit as debit or vice versa. This error is the result of making accounting entries in the wrong account. Organizations often confuse this mistake with a principle error because of their similarities. Entry reversal can disrupt checks and balances, creating chaos in your accounting system.
Entry reversal error example
One common entry reversal error is when businesses mistakenly credit the total COGS and debit the inventory on balance sheets. Ideally, they should debit the COGS and credit the total inventory.
Businesses typically identify entry reversal errors by looking at additional income or expenses outside credits and debits. Also, consider double-checking accounting entry categories to find these mistakes.
5. Error of principle
A principle error results from wrongfully applying accounting principles while making accounting entries.
Principle error example
For example, an accountant makes a principal error while posting a fixed asset purchase under operating expenses. Operating expenses should only contain day-to-day business expenses.
Financial statement reconciliation can be challenging with too many principle errors. Businesses usually check mismatching credit and debit on cash flow statements or accounting categorizations to find these mistakes. Consider using a cloud accounting solution and hiring professional bookkeepers to avoid these problems.
6. Error of commission
An error of commission is one of the common clerical accounting errors. It happens when an accountant enters a debit or credit transaction into the correct account but in the wrong subsidiary ledger or account.
Error of commission example
Imagine an accountant correctly recording a debit amount of Rupee 1,000 to the accounts payable account but for the wrong vendor. This error shows up in the accounts payable subsidiary ledger. Consider carefully tracking and entering accounts receivable and payable transactions to avoid this error.
7. Compensating error
A compensating error occurs when an already-committed error offsets one or more entry errors. For example, an incorrect account payable amount can be balanced out by a wrong amount you recorded in inventory. Both errors have equal amounts but cancel each other since they are in opposite accounts.
Compensating error example
Imagine a business showing inventory worth Rupee 10,000 instead of Rupee 20,000 in the statement. They also recorded the same wrong amount in the accounts payable ledger. The second incorrect entry offsets the first wrong entry, which results in a compensating error.
It is difficult to spot these errors as the offsetting entry compensates for other mistakes. As a result, the trial balance remains unchanged. That’s why accountants may need to look at multiple incorrect entries to find these mistakes.
8. Data entry error
Data entry errors happen when bookkeepers make inaccurate data entries in the books. These basic accounting mistakes occur because of misplaced digits, missing decimals, and transposed numbers. Consider opting for business process automation to prevent these errors.
Data entry error example
Common examples include zero (0) replaced by the letter ‘O’, misplaced numbers, substituting two or more sequential digits, and missing decimals.
9. Closing error
A closing error happens when a business records a transaction in its books after the accounting closing date. Organizations typically reconcile accounts and prepare reports by the closing date. Entering new transactions or modifying existing ones after this date impacts financial statements or future closing.
Closing error example
The new changes impact the financial statement when a company modifies the accounts receivable or payable ledger after the closing date. As a result, the company encounters a closing error.
Accountants can find closing errors by looking at transactions posted after the closing date. Then, they must process a new close to ensure accurate financial accounting. Organizations often set closing passwords to prevent anyone from modifying transactions after the closing date.
10. Reconciliation error
Reconciliation errors refer to missing or duplicate entries that businesses notice during income and expense reconciliation. Forgetting to post deposit, transfer, or payment transactions often results in this type of error.
Reconciliation error example
Imagine a business noticing missing accounts receivable entries while reconciling the second quarter earnings in 2023. They will mark this mismatch as a reconciliation error.
Accountants can identify these errors by examining the mismatch between checks and balances. The best way to solve a reconciliation error is to reconcile the accounts once more and account for all transactions.
Impact of accounting errors
Accounting errors have a lasting impact on an organization’s finances. Besides causing compliance reporting and tax filing-related problems, accounting mistakes can undermine a company’s credibility among customers and suppliers. That’s why small businesses and enterprises alike strive to minimize errors and their impact.
Check out the potential effects of accounting mistakes below.
- Inaccurate financial reporting: Accounting mistakes like duplicate entries or miscategorized transactions make it difficult for organizations to understand their finances accurately. Consequently, they may accidentally understate or overstate revenue or expenses, impacting investment decisions and performance metrics.
- Legal consequences: Unchecked accounting errors result in non-compliance with accounting principles and regulations set by GAAP and IFRS. Violating these standards may attract regulatory investigations and legal penalties.
- Vendor and stakeholder relationships: Even minor accounting mistakes can cause vendors and stakeholders to question an organization’s financial stability. For example, enterprises not processing vendor payments because of accounting inefficiencies may damage supplier relationships and supply chain efficiency.
- Loss of credibility, trust, and reputation: Accounting errors damage a company’s reputation and creditworthiness in front of financial institutions, investors, and lenders. Moreover, financial inaccuracies negatively impact an organization’s brand perception.
Detecting accounting errors
Simple accounting errors occur either because of a lack of care or outdated accounting solutions. In most cases, accounting departments can spot these errors with a thorough scrutiny of their records. While some organizations conduct these activities during month-end closings, others prefer doing it weekly.
Consider following these tips to find mistakes and inaccuracies during reconciliation or matching books.
- Maintain an audit trail: An audit trail refers to a set of documents that trace the sources of financial records. These documents help you to find and cross-check purchase, sales, and expense-related data from different accounting books. Enterprises use audit trails when they can’t resolve balance sheet discrepancies.
- Double-check entries: Another method to find errors is to double-check and match system entries against documents you have. When you encounter an incorrect number, reversed entry, or transposed digit, change it immediately.
- Conduct regular reconciliations: Reconciling transactions with financial records helps you find errors and match balances. For example, you can compare corporate credit card statements, receipts, and bank statements to find the mistakes and fix them with new journal entries.
- Follow a consistent process: Regularly reviewing books makes it easy to find and address errors. For example, you can follow a weekly or monthly cadence to cross-check transactions and prevent them from becoming more significant.
Common causes of accounting errors
Besides human errors, accounting mistakes are often the result of complex transactions, misunderstanding of rules, and inadequate training.
- Human mistakes: Most common errors like duplicate entries, transposed digits, and missed numbers result from human errors. That’s why accountants must be extremely careful while recording transactions.
- Misunderstanding rules: Inexperienced accountants may not fully understand complex accounting principles. As a result, they may record transactions or prepare statements incorrectly.
- Complex records: The more complex financial transactions are, the more the chances of errors. That’s why accountants must pay attention to intricate details to prevent misinterpretations.
- Lack of accounting solutions: Not using up-to-date accounting software can result in inaccurate calculations and reporting.
Learn More About: Difference Between Cost Accounting and Financial Accounting
To err is human.
Reducing business accounting mistakes starts with accurately classifying and entering transactions on the books. Consider following the steps below to prevent errors from happening frequently.
- Avoid employee overload: Overloaded employees often juggle too many tasks, increasing the chance of human errors. Consider simplifying accounting processes so employees have enough time to complete data entry tasks flawlessly. For example, you can introduce expense reporting software to streamline business expense tracking, reimbursement, and reconciliation.
- Implement adequate internal controls: Setting internal policies and following best practices are vital for avoiding errors. For example, you can set up a monthly cadence to remind your team about conducting reconciliations and verifying transactions. These robust internal controls help organizations prevent a simple mistake from causing widespread repercussions.
- Provide data entry training: Training is essential for updating accountants about accounting systems and documentation procedures. Once they learn the ropes of company policies, they can accurately verify and record accounting entries.
- Track the difference between budget and expenses: Finding the gap between actual expenses and business budget helps you find incorrect entries. Imagine you set up a Rupees 100,000 budget for buying a new printer. When the expense entry shows you spent Rupees 10,000, you can compare it against the budget. In this case, an accountant missed adding the last digit.
- Use the latest accounting software: Whether free or paid, consider updating your accounting software regularly for seamless data sync across systems.
Now, let’s look at the steps organizations follow to correct accounting mistakes.
Correcting accounting errors
Enterprises use ‘correcting entries’ to fix mistakes they make while recording transactions on the books. A ‘correcting entry’ is a journal entry that rectifies an accounting error by adjusting retained earnings for a period. These entries follow the double-entry bookkeeping rule.
You can apply ‘correcting entries’ for categorization and mathematical errors. However, these entries can’t be used to fix ‘counterbalancing errors,’ where two mistakes cancel out. Check out the steps below to learn how to make a ‘correcting entry.’
- Find the wrong entry: The process starts with identifying the erroneous entry in the accounting book.
- Rectify the incorrect entry: The next step involves an accountant adding a rectified record for the wrong entry from the previous stage.
- Pass the ‘correcting entry’: An accountant uses a single journal entry or reversal entry to pass the ‘correcting entry’. Reversing entries requires you to add new records to cancel out one of the previous entries. You can add the record directly to rectify the mistake in single-entry bookkeeping.
Companies can also review trial balances or reconciliations to find different accounting mistakes. However, trial balances may not help you spot offsetting entries, whereas statement reconciliation is more efficient for catching errors.
Let’s take the example of J&B Private Limited, a multi-national business consulting firm. They purchased cash flow management software from A&Y Tech for Rupees 500. They should record the amount they paid the software provider but forgot.
To: A&Y Tech A/C
This is an error of omission, where J&B didn’t enter the spend in their books. It’ll also be considered an omission error if J&B forgets to record entries in respective ledgers.
Now, imagine J&B has payroll expenses worth Rupees 100,000 every month. In July, they also made five sales worth Rupees 59,000.32, 2093.67, 23000.25, 8,000, and 7905.76. They made mistakes while adding these entries to the journal. Plus, they received accounts receivables worth Rupees 20,700. Here’s what their book looks like.
Payroll, September, 2023
Sales: client 1
Sales: client 2
Sales: client 3
Sales: client 4
Sales: client 5
The ledger shows that the trial balance matches perfectly, as the credit and debit sides show entries worth Rupees 100,000. However, J&B entered Rupees 2,300.25 for the third sales entry, which was worth Rupees 23,000.25. This is a classic example of commission error, where transactions record wrong amounts.
Quick Read: Best Free Accounting Software in 2023
Role of technology in reducing errors
AI-enabled accounting automation is a game-changer for processing large data batches, detecting discrepancies, enhancing data, and offering real-time financial visibility.
- Data entry automation: Cutting-edge accounting solutions use optical character recognition for data extraction from paper documents. This automated data capture helps you save time while eliminating human errors.
- Seamless integration: Accounting solutions can also integrate with your existing tech stack. Consequently, accountants don’t have to spend time making redundant data entries. Moreover, the financial data remains up-to-date across business systems, making it easier to make business decisions.
- Automated reconciliation: Reconciling complex transactions can be time-consuming. Accounting systems let you automate financial record comparisons with bank account statements. The result is a smooth reconciliation process free from calculation errors.
- Data processing: Accounting solutions can also send real-time alerts in case of accounting errors and inconsistencies. Accountants use these real-time alerts to rectify existing mistakes and make changes in financial reports.
Accurate financial records are crucial for meeting regulatory compliance and making informed business decisions. Unintentional accounting errors often prevent organizations from maintaining financial accuracy. As a result, they don’t get an accurate financial overview or may even face legal consequences. That’s why it’s essential to be aware of different types of errors and learn how to address them. Using accounting software helps organizations prevent manual accounting mistakes, streamline processes, and have error-free financial data.
Common types of accounting errors are:
1. Data entry error
2. Omission error
3. Duplication error
4. Entry reversal error
5. Compensating error
6. Reconciliation error
7. Closing error
Accounting errors are often the reason behind inaccurate income or expense reports. For example, a business may end up understating or overstating profits because of accounting mistakes. These financial inaccuracies result in stakeholders and investors questioning a company’s credibility.
You can track invoices, double-check entries, follow an audit trail, and conduct monthly bank reconciliations to prevent accounting mistakes.
You can correct an error by adding a ‘correcting entry’ in the books. ‘Correcting entries’ are part of accrual accounting and fix the retained earnings for a period to fix errors.
Accounting errors prevent businesses from having a comprehensive, accurate financial summary. As a result, they aren’t able to make sound investment decisions and may face regulatory fines. Companies not sharing factual financial statements also suffer from reputational damage.
AI-powered accounting tools can help in mitigating accounting mistakes. For example, these solutions automate reconciliation, data entry, and data processing processes prone to human errors. These accounting systems can also flag accounting errors and send real-time alerts.
The US-based energy company Enron Corporation hid its debt to overstate profits. Consequently, they went bankrupt despite having $60 billion in assets. In another example, the e-commerce marketplace Groupon posted fourth-quarter earnings without considering refunds in 2012. This clerical error increased their losses from $42.7 million to $62.9 million.
Incorrect accounting entries cause imbalances in financial statements. As a result, businesses aren’t able to conduct financial analysis, plan financial investments, or assess organizational performance.
Not correcting errors can result in cash flow challenges, reputational damage, bankruptcy, regulatory audits, and legal penalties.
Financial service providers, healthcare companies, large-scale retailers, and manufacturers will likely see more errors due to the nature and complexity of financial transactions.
You should disclose error correction in the annual report. Consider speaking to an accounting professional and a legal advisor to learn how to best address this situation.
It’s best to conduct regular reviews every month to spot potential errors.
Filing incorrect financial statements may attract legal penalties, lawsuits, and audits from local regulatory bodies.
Consider reconciling all accounts and match transactions against bank statements and other records. This comparison should help you identify the source.
Accounting training and education aid accountants better understand accounting principles and regulations. Learning these best practices enables them to prepare financial statements following accounting standards.
An accounting error is unintentional. Unlike fraud, this error isn’t made intentionally to modify entries for a company’s benefit.
Consider using accounting software, training accountants regularly, implementing robust internal controls, and avoiding employee overload to minimize the risk of errors.