{"id":122,"date":"2024-09-06T16:46:39","date_gmt":"2024-09-06T16:46:39","guid":{"rendered":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/adjusting-for-errors\/"},"modified":"2024-09-13T02:05:50","modified_gmt":"2024-09-13T02:05:50","slug":"adjusting-for-errors","status":"publish","type":"chapter","link":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/adjusting-for-errors\/","title":{"raw":"Adjusting for Errors","rendered":"Adjusting for Errors"},"content":{"raw":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\r\n<ul>\r\n \t<li>Finding errors and creating adjustments<\/li>\r\n<\/ul>\r\n<\/section>&nbsp;\r\n\r\n<img class=\"alignright wp-image-3326\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12215714\/eraser-3822402_1920-1024x576.jpg\" alt=\"A pink and blue eraser\" width=\"400\" height=\"225\" \/>Sometimes things just don\u2019t get recorded correctly. Remember, we have an external expectation of materiality as we saw in the introduction to this section, looking at Ernst &amp; Young, LLP accounting firm\u2019s opinion on the Alphabet, Inc. financial statements. For Alphabet, the numbers on the balance sheet are rounded to the nearest <em>million<\/em>. A $100,000 error may not be material if it won\u2019t affect the reported numbers. However, there is also a practical aspect to materiality.\r\n\r\nThe cash account in your company may be off by $100, which may not concern you, except it is <em>possible<\/em> that someone stole $17,900 and someone else recorded a $13,000 deposit as $31,000 overstatement mistake on a deposit. When we get to the section on accounting for cash, we\u2019ll learn ways to avoid this kind of thing, but for now, let\u2019s just say that if we find an error, or a couple of errors, in our trial balance, we have to do some research, sketch out some T accounts, and make correcting journal entries.\r\n\r\nMaybe an asset was recorded as an expense, or someone recorded a journal entry backward. Each of these situations will have to be addressed according to the specific situation.\u00a0<span style=\"font-size: 1em;\">It is good practice to routinely run checks to catch errors and create the necessary journal adjusting entries.\u00a0<\/span><span style=\"font-size: 1rem; text-align: initial;\">Start the process by asking yourself these three questions when dealing with errors:\u00a0<\/span>\r\n<ol>\r\n \t<li>What type of error is it?<\/li>\r\n \t<li>How should this error be fixed?<\/li>\r\n \t<li>How did this error affect the financial statements?<\/li>\r\n<\/ol>\r\n<h2>What type of error is it?<\/h2>\r\nOnce you have discovered there is an error evaluate what type of accounting error it is. Here are examples of common accounting errors to watch for:\r\n<ul>\r\n \t<li><strong>Transposition Error.<\/strong> Reversing or transposing digits (e.g. 3874 instead of 3784)<\/li>\r\n \t<li><strong>Omission Error.<\/strong> A transaction isn't recorded like a sale or expense is overlooked (example: a cash sale of a TV wasn't written down in the rush of a black Friday sale).<\/li>\r\n \t<li><strong>Entry Reversal.<\/strong> An entry is debited instead of credited or vice versa.<\/li>\r\n \t<li><strong>Subsidiary Entries.<\/strong> A transaction is incorrectly entered, usually not caught until reconciling the bank statement.<\/li>\r\n \t<li><strong>Rounding Error.<\/strong> When a number is rounded up or down and can have a cascading effect on subsequently calculated figures.<\/li>\r\n \t<li><strong>Error of Commission.<\/strong> An amount is entered as the correct account and amount, but is actually incorrect. For example, an amount was added instead of subtracted or charged on one invoice when it should have been applied to a different invoice.<\/li>\r\n<\/ul>\r\n<h2>How should this error be fixed?<\/h2>\r\nNow that you understand what type of error it is, it's time to classify it as a deferral (also known as prepayment) or an accrual. Then ask, \"Is it part of accrued revenue, accrued expense, deferred (unearned) revenue, or deferred (prepaid) expense?\" Once those steps have been discovered, an adjusted journal entry is created to fix it.\r\n\r\n<span style=\"font-size: 1em;\">In prior readings we've gone over the different types and posting adjusting entries, but here<\/span><span style=\"font-size: 1rem; text-align: initial;\">\u00a0is a quick example of an adjusted entry made to the general ledger after a physical count of inventory corrected an inventory discrepancy.<\/span>\r\n<table class=\"fin-table gridded\"><caption class=\"u-clearfix\"><span style=\"text-transform: uppercase;\">Journal<\/span><\/caption>\r\n<thead>\r\n<tr aria-hidden=\"true\">\r\n<td colspan=\"4\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"col\">Date<\/th>\r\n<th scope=\"col\">Description<\/th>\r\n<th scope=\"col\">Debit<\/th>\r\n<th scope=\"col\">Credit<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>31-Dec<\/td>\r\n<td>Cost of goods sold<\/td>\r\n<td>600<\/td>\r\n<td><\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td>Inventory<\/td>\r\n<td><\/td>\r\n<td>600<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td><em>Adjustment for inventory shrinkage.<\/em><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nNow,\u00a0<span style=\"font-size: 1em;\">let's move on to the final step.<\/span>\r\n<h2>How did this error affect the financial statements?<\/h2>\r\nThe last step is to understand how an error before it is adjusted, can<span style=\"font-size: 1em; text-align: initial;\">\u00a0<\/span><span style=\"font-size: 1rem; text-align: initial;\">overstate or understate the\u00a0<span style=\"font-size: 1em; text-align: initial;\">Income Statement and Balance Sheet. Er<\/span>rors in the accrued and deferred (unearned or prepaid) revenues and expenses affect the\u00a0<span style=\"font-size: 1em; text-align: initial;\">Balance Sheet<\/span>\u00a0and\u00a0<span style=\"font-size: 1em; text-align: initial;\">Income Statement in the following manner<\/span>:<\/span>\r\n<table><caption>Before Adjusting<\/caption>\r\n<thead>\r\n<tr>\r\n<th rowspan=\"2\" scope=\"col\">Adjusting Entry Not Recorded<\/th>\r\n<th style=\"text-align: left;\" colspan=\"3\" scope=\"col\">Balance Sheet<\/th>\r\n<th style=\"text-align: left;\" colspan=\"3\" scope=\"col\">Income Statement<\/th>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"col\">Assets<\/th>\r\n<th scope=\"col\">Liabilities<\/th>\r\n<th scope=\"col\">Equity<\/th>\r\n<th scope=\"col\">Revenue<\/th>\r\n<th scope=\"col\">Expenses<\/th>\r\n<th scope=\"col\">Net Income<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<th scope=\"row\">Accrued Revenues<\/th>\r\n<td>Understated<\/td>\r\n<td><\/td>\r\n<td>Understated<\/td>\r\n<td>Understated<\/td>\r\n<td><\/td>\r\n<td>Understated<\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"row\">Accrued Expenses<\/th>\r\n<td><\/td>\r\n<td>Understated<\/td>\r\n<td>Overstated<\/td>\r\n<td><\/td>\r\n<td>Understated<\/td>\r\n<td>Overstated<\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"row\">Unearned Revenues<\/th>\r\n<td><\/td>\r\n<td>Overstated<\/td>\r\n<td>Overstated<\/td>\r\n<td>Understated<\/td>\r\n<td><\/td>\r\n<td>Understated<\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"row\">Prepaid Expenses<\/th>\r\n<td>Overstated<\/td>\r\n<td><\/td>\r\n<td>Overstated<\/td>\r\n<td><\/td>\r\n<td>Understated<\/td>\r\n<td>Overstated<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<section class=\"textbox watchIt\" aria-label=\"Watch It\">\r\n<p>To review the big picture about adjusting entries, watch this video:<\/p>\r\n<p>\r\n<iframe width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/H0N7tvXuJlU?t=232\"><\/p>\r\n<p>\r\nYou can view the <a href=\"https:\/\/course-building.s3-us-west-2.amazonaws.com\/Financial+Accounting\/Transcripts\/PaymentsAndAccrualsAdjustingEntries_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for \"Prepayments and Accruals | Adjusting Entries\" here (opens in new window)<\/a>.\r\n<\/p>\r\n<\/section>&nbsp;\r\n\r\n&nbsp;\r\n\r\nIn this practice section, you\u2019ll have a chance to exercise your investigative and problem-solving skills.\r\n\r\n<section class=\"textbox tryIt\" aria-label=\"Try It\">[ohm2_question hide_question_numbers=1]25133[\/ohm2_question]\r\n[ohm_question]201805[\/ohm_question]<span style=\"font-family: 'Public Sans', -apple-system, BlinkMacSystemFont, 'Segoe UI', Roboto, Oxygen-Sans, Ubuntu, Cantarell, 'Helvetica Neue', sans-serif;\">\u00a0<\/span>\r\n\r\n<\/section>","rendered":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\n<ul>\n<li>Finding errors and creating adjustments<\/li>\n<\/ul>\n<\/section>\n<p>&nbsp;<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignright wp-image-3326\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12215714\/eraser-3822402_1920-1024x576.jpg\" alt=\"A pink and blue eraser\" width=\"400\" height=\"225\" \/>Sometimes things just don\u2019t get recorded correctly. Remember, we have an external expectation of materiality as we saw in the introduction to this section, looking at Ernst &amp; Young, LLP accounting firm\u2019s opinion on the Alphabet, Inc. financial statements. For Alphabet, the numbers on the balance sheet are rounded to the nearest <em>million<\/em>. A $100,000 error may not be material if it won\u2019t affect the reported numbers. However, there is also a practical aspect to materiality.<\/p>\n<p>The cash account in your company may be off by $100, which may not concern you, except it is <em>possible<\/em> that someone stole $17,900 and someone else recorded a $13,000 deposit as $31,000 overstatement mistake on a deposit. When we get to the section on accounting for cash, we\u2019ll learn ways to avoid this kind of thing, but for now, let\u2019s just say that if we find an error, or a couple of errors, in our trial balance, we have to do some research, sketch out some T accounts, and make correcting journal entries.<\/p>\n<p>Maybe an asset was recorded as an expense, or someone recorded a journal entry backward. Each of these situations will have to be addressed according to the specific situation.\u00a0<span style=\"font-size: 1em;\">It is good practice to routinely run checks to catch errors and create the necessary journal adjusting entries.\u00a0<\/span><span style=\"font-size: 1rem; text-align: initial;\">Start the process by asking yourself these three questions when dealing with errors:\u00a0<\/span><\/p>\n<ol>\n<li>What type of error is it?<\/li>\n<li>How should this error be fixed?<\/li>\n<li>How did this error affect the financial statements?<\/li>\n<\/ol>\n<h2>What type of error is it?<\/h2>\n<p>Once you have discovered there is an error evaluate what type of accounting error it is. Here are examples of common accounting errors to watch for:<\/p>\n<ul>\n<li><strong>Transposition Error.<\/strong> Reversing or transposing digits (e.g. 3874 instead of 3784)<\/li>\n<li><strong>Omission Error.<\/strong> A transaction isn&#8217;t recorded like a sale or expense is overlooked (example: a cash sale of a TV wasn&#8217;t written down in the rush of a black Friday sale).<\/li>\n<li><strong>Entry Reversal.<\/strong> An entry is debited instead of credited or vice versa.<\/li>\n<li><strong>Subsidiary Entries.<\/strong> A transaction is incorrectly entered, usually not caught until reconciling the bank statement.<\/li>\n<li><strong>Rounding Error.<\/strong> When a number is rounded up or down and can have a cascading effect on subsequently calculated figures.<\/li>\n<li><strong>Error of Commission.<\/strong> An amount is entered as the correct account and amount, but is actually incorrect. For example, an amount was added instead of subtracted or charged on one invoice when it should have been applied to a different invoice.<\/li>\n<\/ul>\n<h2>How should this error be fixed?<\/h2>\n<p>Now that you understand what type of error it is, it&#8217;s time to classify it as a deferral (also known as prepayment) or an accrual. Then ask, &#8220;Is it part of accrued revenue, accrued expense, deferred (unearned) revenue, or deferred (prepaid) expense?&#8221; Once those steps have been discovered, an adjusted journal entry is created to fix it.<\/p>\n<p><span style=\"font-size: 1em;\">In prior readings we&#8217;ve gone over the different types and posting adjusting entries, but here<\/span><span style=\"font-size: 1rem; text-align: initial;\">\u00a0is a quick example of an adjusted entry made to the general ledger after a physical count of inventory corrected an inventory discrepancy.<\/span><\/p>\n<table class=\"fin-table gridded\">\n<caption class=\"u-clearfix\"><span style=\"text-transform: uppercase;\">Journal<\/span><\/caption>\n<thead>\n<tr aria-hidden=\"true\">\n<td colspan=\"4\"><\/td>\n<\/tr>\n<tr>\n<th scope=\"col\">Date<\/th>\n<th scope=\"col\">Description<\/th>\n<th scope=\"col\">Debit<\/th>\n<th scope=\"col\">Credit<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>31-Dec<\/td>\n<td>Cost of goods sold<\/td>\n<td>600<\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td>Inventory<\/td>\n<td><\/td>\n<td>600<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td><em>Adjustment for inventory shrinkage.<\/em><\/td>\n<td><\/td>\n<td><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>Now,\u00a0<span style=\"font-size: 1em;\">let&#8217;s move on to the final step.<\/span><\/p>\n<h2>How did this error affect the financial statements?<\/h2>\n<p>The last step is to understand how an error before it is adjusted, can<span style=\"font-size: 1em; text-align: initial;\">\u00a0<\/span><span style=\"font-size: 1rem; text-align: initial;\">overstate or understate the\u00a0<span style=\"font-size: 1em; text-align: initial;\">Income Statement and Balance Sheet. Er<\/span>rors in the accrued and deferred (unearned or prepaid) revenues and expenses affect the\u00a0<span style=\"font-size: 1em; text-align: initial;\">Balance Sheet<\/span>\u00a0and\u00a0<span style=\"font-size: 1em; text-align: initial;\">Income Statement in the following manner<\/span>:<\/span><\/p>\n<table>\n<caption>Before Adjusting<\/caption>\n<thead>\n<tr>\n<th rowspan=\"2\" scope=\"col\">Adjusting Entry Not Recorded<\/th>\n<th style=\"text-align: left;\" colspan=\"3\" scope=\"col\">Balance Sheet<\/th>\n<th style=\"text-align: left;\" colspan=\"3\" scope=\"col\">Income Statement<\/th>\n<\/tr>\n<tr>\n<th scope=\"col\">Assets<\/th>\n<th scope=\"col\">Liabilities<\/th>\n<th scope=\"col\">Equity<\/th>\n<th scope=\"col\">Revenue<\/th>\n<th scope=\"col\">Expenses<\/th>\n<th scope=\"col\">Net Income<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<th scope=\"row\">Accrued Revenues<\/th>\n<td>Understated<\/td>\n<td><\/td>\n<td>Understated<\/td>\n<td>Understated<\/td>\n<td><\/td>\n<td>Understated<\/td>\n<\/tr>\n<tr>\n<th scope=\"row\">Accrued Expenses<\/th>\n<td><\/td>\n<td>Understated<\/td>\n<td>Overstated<\/td>\n<td><\/td>\n<td>Understated<\/td>\n<td>Overstated<\/td>\n<\/tr>\n<tr>\n<th scope=\"row\">Unearned Revenues<\/th>\n<td><\/td>\n<td>Overstated<\/td>\n<td>Overstated<\/td>\n<td>Understated<\/td>\n<td><\/td>\n<td>Understated<\/td>\n<\/tr>\n<tr>\n<th scope=\"row\">Prepaid Expenses<\/th>\n<td>Overstated<\/td>\n<td><\/td>\n<td>Overstated<\/td>\n<td><\/td>\n<td>Understated<\/td>\n<td>Overstated<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<section class=\"textbox watchIt\" aria-label=\"Watch It\">\n<p>To review the big picture about adjusting entries, watch this video:<\/p>\n<p>\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/H0N7tvXuJlU?t=232\"><\/iframe><\/p>\n<p>\nYou can view the <a href=\"https:\/\/course-building.s3-us-west-2.amazonaws.com\/Financial+Accounting\/Transcripts\/PaymentsAndAccrualsAdjustingEntries_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for &#8220;Prepayments and Accruals | Adjusting Entries&#8221; here (opens in new window)<\/a>.\n<\/p>\n<\/section>\n<p>&nbsp;<\/p>\n<p>&nbsp;<\/p>\n<p>In this practice section, you\u2019ll have a chance to exercise your investigative and problem-solving skills.<\/p>\n<section class=\"textbox tryIt\" aria-label=\"Try It\"><iframe loading=\"lazy\" id=\"ohm25133\" class=\"resizable\" src=\"https:\/\/ohm.one.lumenlearning.com\/multiembedq.php?id=25133&theme=lumen&iframe_resize_id=ohm25133&source=tnh\" width=\"100%\" height=\"150\"><\/iframe><br \/>\n<iframe loading=\"lazy\" id=\"ohm201805\" class=\"resizable\" src=\"https:\/\/ohm.lumenlearning.com\/multiembedq.php?id=201805&theme=lumen&iframe_resize_id=ohm201805&source=tnh&show_question_numbers\" width=\"100%\" height=\"150\"><\/iframe><span style=\"font-family: 'Public Sans', -apple-system, BlinkMacSystemFont, 'Segoe UI', Roboto, Oxygen-Sans, Ubuntu, Cantarell, 'Helvetica Neue', sans-serif;\">\u00a0<\/span><\/p>\n<\/section>\n","protected":false},"author":6,"menu_order":8,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Adjusting for Errors\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"copyrighted_video\",\"description\":\"Prepayments and Accruals | Adjusting Entries\",\"author\":\"Accounting Stuff\",\"organization\":\"\",\"url\":\"https:\/\/www.youtube.com\/watch?v=H0N7tvXuJlU&feature=emb_logo\",\"project\":\"\",\"license\":\"arr\",\"license_terms\":\"Standard YouTube License\"},{\"type\":\"cc\",\"description\":\"\",\"author\":\"MasterTux\",\"organization\":\"\",\"url\":\"https:\/\/pixabay.com\/photos\/eraser-abrasion-stationery-office-3822402\/\",\"project\":\"\",\"license\":\"cc0\",\"license_terms\":\"https:\/\/pixabay.com\/service\/terms\/#license\"}]","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"part":114,"module-header":"- Select Header -","content_attributions":[{"type":"original","description":"Adjusting for Errors","author":"Joseph Cooke","organization":"Lumen Learning","url":"","project":"","license":"cc-by","license_terms":""},{"type":"copyrighted_video","description":"Prepayments and Accruals | Adjusting Entries","author":"Accounting Stuff","organization":"","url":"https:\/\/www.youtube.com\/watch?v=H0N7tvXuJlU&feature=emb_logo","project":"","license":"arr","license_terms":"Standard YouTube License"},{"type":"cc","description":"","author":"MasterTux","organization":"","url":"https:\/\/pixabay.com\/photos\/eraser-abrasion-stationery-office-3822402\/","project":"","license":"cc0","license_terms":"https:\/\/pixabay.com\/service\/terms\/#license"}],"internal_book_links":[],"video_content":null,"cc_video_embed_content":{"cc_scripts":"","media_targets":[]},"try_it_collection":null,"_links":{"self":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/122"}],"collection":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/users\/6"}],"version-history":[{"count":6,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/122\/revisions"}],"predecessor-version":[{"id":1058,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/122\/revisions\/1058"}],"part":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/parts\/114"}],"metadata":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/122\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/media?parent=122"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=122"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/contributor?post=122"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/license?post=122"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}