Unit 1DFA 1200

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Financial Accounting DFA 1200

Unit 1 1

UNIT 1 CONTROL ACCOUNTS AND CORRECTION OF

ERRORS

Unit Structure

1.0 Overview

1.1 Learning Objectives

1.2 The Analytical Cash Book

1.3 Definition of Control Accounts

1.3.1 Definition

1.3.2 Principle

1.4 Types of Control Accounts and Their Purpose

1.3.1 Typical Sales Ledger Control Account

1.3.2 Typical Purchases Ledger Control Account

1.3.3 Purpose of Control Accounts

1.5 Do Control Accounts from Part of the Double Entry System?

1.4.1 Control Accounts form Part of the Double Entry System

1.4.2 Control Accounts do NOT Form Part of the Double Entry System

1.6 Types of Errors in the Accounts

1.6.1 Errors which do not Affect the Trial Balance

1.6.2 Errors which Affect the Trial Balance and the Suspense Account

1.7 Procedure for Tackling Identified Errors

1.8 Illustrative Example

1.9 Summary

1.10 Practice Question

1.0 OVERVIEW

This Unit focuses on the principles and procedures in identifying and correcting

accounting errors. Control accounts are in-built accounting techniques which help in

identifying accounting errors. The general procedure for correcting any error involves

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three steps: First, the error needs to be identified; second, what accounting entries have

been done; third, what accounting entries should have been done.

1.1 LEARNING OBJECTIVES

By the end of this Unit, you should be able to do the following:

1. Apply techniques for identifying errors.

2. Discuss the differences which exist in the correction of errors if control accounts

are part of the double entry system as opposed to if they are merely memorandum

accounts.

3. Draw up sales ledger and purchase ledger control accounts.

4. Understand the sources of information for control accounts.

5. Explain the three-step procedure for correcting errors.

1.2 THE ANALYTICAL CASHBOOK

The name cash book may be something of a misnomer because the book is used to

summarise an organisations bank transactions. A companys transaction in cash (i.e.

notes and coins) are usually dealt with through the petty cash book.

Many organisations have two distinct cashbooks a cash payments book and a cash

receipts book but for the examinations it is convenient to think of the cash book as a

single book.

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A typical receipts cash book would be analysed as follows:

Date Details Ledger

reference

Bank Discount

allowed

Sales

ledger

Cash

sales

Sundry

income

2 Feb Cash

sales

100 100

5 Feb S.Black B7 75 5 75

10 Feb J Clark C8 200 200

28 Feb Interest

received 125 125

Total 500 5 275 100 125

Explanatory note:

The above analytical receipts side of the cash book shows how the different bank receipts

(column 4) have been analysed. For instance, the business has received Rs75 from S.

Black, a debtor, and has granted him a discount allowed of Rs5. Note that the analytical

cash book gives details of individual entries in chronological order but also gives total

figures: for instance, we have total cash paid by debtors (6th

Column) Rs275 and total

cash discount allowed (5th Column) Rs5.

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A typical payment cash book would be analysed as follows:

Date Details Ledger

reference

Bank Discount

received

Purchases

ledger

Cash

purchases

Sundry

expense

2 Mar Cash

purchases

200 200

5 Mar Tom T7 150 50 150

10 Mar Jerry J8 200 50 200

31 Mar Interest

paid 150 150

Total 700 100 350 200 150

The above analytical payments side of the cash book shows how the different bank

payments (column 4) have been analysed. For instance, the business has paid Rs150 to

Tom, a creditor, and has been granted a discount received of Rs50. Note that the

analytical payment side of the cash book gives details of individual entries in

chronological order but also gives total figures: for instance, we have total cash paid to

creditors (6th

Column) Rs350 and total cash discount received (5th

Column) Rs100.

1.3 DEFINITION OF CONTROL ACCOUNTS

1.3.1 Definition

A control account is an account which records the total value of individual entries which

have increased and decreased the account or a group of like accounts.

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1.3.2 Principle

The principle on which the control account is based is simple. Taking the example of

account, if the opening balance is known together with information of the sum total of the

individual additions and deductions entered into the account, the closing balance can be

calculated.

Rs

Opening balance X

Add TOTAL of individual entries which have increased the balance X

Less TOTAL of individual entries which have decreased the balance (X)

Closing balance X

1.4 TYPES OF CONTROL ACCOUNTS AND THEIR PURPOSE

1.4.1 Typical Sales Ledger Control Account or Debtors Total Account

A sales ledger control account or Debtors total account controls the sales ledger in the

sense that the totals appearing on the debit and credit side of the debtors total account

should tally with the sum total of individual entries which over time have increased or

decreased individual debtor accounts in the sales ledger. This means that the balance on

the debtors total account should tally with the sum of individual balances on the sales

ledger (Recall that the sales ledger records the chronological entries in each individual

debtor account).

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Debtors total account

Rs Rs

Balance B/F (should tally with

sum of sales ledger debit

balances at end of previous

period X

Balance B/f (total of

sales ledger credit

balances b/f from

previous period) X

Credit sales (total in sales day

book) X

Return inwards (total of

Return inwards book) X

Dishonored cheques (Bank

statement and cash book) X

Bad debts (journal) X

Cash received from

debtors (sales ledger

column in the analytical

cash book)

X

Cash discounts allowed

(total of discount

column of cash book) X

Balance c/d (should tally

with sum of debit

balance on the individual

debtor accounts in the

sales ledger) X

X X

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Explanatory note

The sources of information for control accounts are total figures from sales day book,

return inwards day book, relevant totals (e,g. total cash received from debtors, total

discounts allowed from cash book) from the analytical cash book and relevant figures

from the journal. Recall that the journal keeps a record of any event which is not recorded

by the cash book, sales day book and returns inwards day book.

Since the debtors total account sources its information from total figures, it acts as a

control over the sum of individual debtor balances in the sales ledger, the entries to which

are posted in chronological order to each individual debtor account.

1.4.2 Typical Purchase Ledger Control Account or Creditors Total

Account

A purchase ledger control account or creditors total account controls the purchase ledger

in the sense that the totals appearing on the debit and credit side of the purchase total

account should tally with the sum total of individual entries which over time have

increased or decreased individual creditor accounts in the purchases ledger. This means

that the balance on the creditors total account should tally with the sum of individual

balances on the purchases ledger (Recall that the purchases ledger records the

chronological entries in each individual creditor account).

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Creditors total account

Rs Rs

Balance B/F (should tally with

sum of purchases ledger debit

balances at end of previous

period) X

Balance B/f (if any)

(total of purchases ledger

credit balances b/f from

previous period) X

Cash paid to creditors

(Purchase ledger column in

cash book) X

Credit purchases (total

in purchases day book) X

Return outwards (total of

Return outwards book) X

Cash discounts received (total

of discount column of cash

book) X

Balance c/d (should tally with

sum of credit balances on the

individual creditor accounts in

the purchases ledger) X

X X

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Explanatory note

The sources of information for the creditors total account are total figures from

purchases day book, return outwards day book and relevant totals (e,g. total cash paid to

trade creditors, total of the discounts received column in the cash book) from the

analytical cash book.

1.4.3 Purposes of Control Accounts

To act as independent checks on the arithmetical accuracy of the aggregates of the

balances in the sales and purchases ledgers.

To provide total of debtors and creditors quickly when a trial balance is prepared.

To identify the ledger or ledgers in which errors have been made when there is a

discrepancy between the total account and the sum of the individual ledger

balances.

To act as an independent internal check on the work of the sales and purchasesledger clerks, to detect errors and deter fraud. There should be segregation of

duties of sales ledger clerks, purchase ledger clerks and those who maintain

control accounts.

1.5 DO CONTROL ACCOUNTS FORM PART OF THE DOUBLE

ENTRY SYSTEM?

1.5.1 Control Accounts are Part of The Double Entry System

Usually, control accounts i.e. the debtors total account and the creditors total account are

an integral part of the double entry system. If this is so, then the sales ledger and the

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purchases ledger will only be memorandum accounts i.e. accounts which are not part of

the double entry system and which are kept only for reference and control purposes.

Example:

Suppose the following information is given from page 1 the sales day book:

Date Customer Amount (Rs)

10 Jan Ally 100

15 Jan Bernie 200

25 Jan Constance 300

Total (page 1 sales book) SD1 600

The double entry would be:

DR Total debtors account (SD1) Rs600

CR Sales account Rs600

The sales ledger would keep for memorandum only an account for each individual

debtor to which will be debited Rs100, Rs200 and Rs300 to the respective accounts ofAlly, Bernie and Constance.

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1.5.2 Control Accounts are NOT Part of the Double Entry System

In the rare cases where control accounts are memorandum only, the sales ledger and the

purchases ledger would then be part of the double entry system. Using the same example

as above, the double entries would be:

Date Amount (Rs)

10 Jan Dr Debtor (Ally) 100

Cr Sales account 100

15 Jan Dr Debtor (Bernie) 200


25 Jan Dr Debtor (Constance) 300


The debtors total account would be kept for memorandumonly to which will be debited

a total figure of Rs600 from page 1 of the sales book.

1.6 TYPES OF ERRORS IN THE ACCOUNTS

1.6.1 Errors Which do not Affect the Trial Balance

The following are errors which are not disclosed by the trial balance:

(i) Errors of omission

Transaction which have been completely omitted from the books. For instance, if

an invoice of Rs4,000 for the purchase of goods is omitted from the purchase day

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book then neither the purchase accounts will be debited not the creditors account

credited by Rs4,000. The trial balance will be unaffected by the error.

(ii) Errors of commission

These occur when a posting is made to the right type of account but to the wrong

account name. For instance, a sale of goods on credit to Kamal (a debtor) is

posted to in error to another debtor account say K. Amal.

(iii) Errors of principle

These arise when the posting is made to an account which is not only the wrong

account but also one which is not of the correct type. For instance a sales of goods

on credit to Kamal (correct entry would have been Dr Debtors Cr Sales) is posted

in error say to the cash book (Dr Cash, Cr sales).

(iv) Compensating error

These arise when errors cancer each other out. For instance the debit side of the

cash book is overcast by Rs1,000 and the credit side of say a creditors account is

overcast by Rs1,000.

(v) Errors of original entry

This occurs when a transaction is initially recorded in the books with an incorrect

amount. For instance a sale of goods on credit to ABA Ltd is recorded for

Rs2,100 is recorded in the sales day book as Rs1,200. Thus, the debtors account

will be debited by Rs1200 (instead of Rs2,100) and the sales account will credited

with Rs1,200 (instead of Rs2,100).

(vi) Complete reversal of entries

If a cheque for Rs300 is drawn by the business to pay a creditor (say ABC plc)

but the cheque is posted in error to the debit side of the cash book (instead of the

credit side) and to the credit side of ABC plc (instead of to the debit side), the

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bank account will be overstated by Rs600 and the creditor account (ABC plc) will

be overstated by Rs600.

1.6.2 Errors which Affect the Trial Balance and the Suspense Account

These are of course errors, the cumulative effect of which are apparent on the trial

balance since the total of debits will not equate with the total of credits. When this

situation arises, a suspense account is temporarily created to make up the discrepancy. If

debits exceed credits by say Rs1,000, then a suspense account with a credit balance of

Rs1,000 will be inserted in the trial balance. If credits exceed debits by Rs500, then a

suspense account with a debit balance of Rs500 will be inserted in the trial balance. Of

course, when the errors are identified and corrected, the suspense account will be

automatically eliminated.

1.7 PROCEDURE FOR TACKLING ERRORS IN ACCOUNTS

There is a 3-step procedure for correcting identified errors:

Step 1: Identify what entries, if any, have been made in the accounts.

Step 2: Identify what entries SHOULD have been made.

Step 3: Identify what entries are required to correct the error.

Simple example:

A cheque received from a debtor, Rs1,000, has been posted to the debit side of the cash

book and to the debit side of the debtor account in the sales ledger. However, the totaldebtors account has been correctly credited with Rs1,000. Prepare corrective entries

assuming (i) the control accounts are memorandum accounts (ii) the control accounts are

part of the double entry system.

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Solution assuming (i) control accounts are memorandum

Step 1: Entries which have been made:

Dr cash book by Rs1,000 (correct entry).

Dr Debtor account in sales ledger by Rs1,000 (incorrect entry).

Therefore, the trial balance would have Debits exceeding Credits by Rs2,000.

Hence a suspense account account with a credit balance of Rs2,000 would be

created.

Step 2: What entries should have been made?

Dr cash book by Rs1,000 (entry already done).

Cr Debtor account in sales ledger by Rs1,000 (entry not yet done).

Step 3: Entries required to correct the error

Dr Suspense account by Rs2,000

Cr Debtor account by Rs2,000

Tutorial note:

By crediting the debtor account by Rs2,000, we are firstly, canceling the incorrect debit

of Rs1,000 made to the debtor account and, secondly, incorporating the correct credit of

Rs1,000 to the debtor account.

Solution assuming (ii) control accounts are part of the double entry system

In this case NO corrective entries are required since no error has been made in any

account which forms part of the double entry system.

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Therefore, only memorandum corrective entries to the sales ledger would be effected,

i.e., Credit the Debtor account by Rs2,000. (Tutorial Note: No debit entry is required

since the sales ledger is NOT part of the double entry system!)

Word of caution: It is important to read the question carefully to identify whether it is

the ledger or control accounts which form part of the double entry system.

1.8 ILLUSTRATIVE EXAMPLE

Buyrites individual ledger account balances are listed and totaled on a monthly basis and

reconciled to the control account balance. The firms creditors total account is an integral

part of the double entry system. Information for the month of March is as follows:

1) Individual ledger account balances at 31 March have been listed out and totaled as

follows:

Total of debit balances: Rs1,012

Total of credit balances: Rs20,778

2) The purchases ledger control account at 31 March is Rs21,832 (net)

3) The total of the discount received for the month, amounting to Rs1,715, has been

posted neither to the control account nor to the discount received account.

4) On listing out the individual purchase ledger balances, an individual credit

balance of Rs205 was incorrectly treated as a debit.

5) A petty cash payment to a supplier amounting to Rs63 has been correctly treated

in the control account but no entry has been made in the individual suppliers

individual ledger account.

6) The purchases daybook total for March has been understated by Rs2,000.

7) Contras (set-offs) in the sales ledger, amounting to Rs2,004, have been correctly

treated in the individual ledger accounts but no entry has been made in the control

account.

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Required:

(a) Prepare journal entries to correct the above errors.

(b) Prepare the corrected creditors total account and a revised total of the

purchase ledger balances (net).

Solution:

Item 3

Dr Total Creditors account Rs1,715

Cr Discount received Rs1,715

No adjustment required to the memorandum purchases ledger.

Item 4

No error has occurred in the control accounts. So, no double entry is required.

No error has occurred in the purchases ledger. It is only when the balances were listed

out, that a credit balance was inadvertently treated as a debit balance. Thus, the sum of

the credit balance in purchase ledger should be increased by Rs205 and the sum of debit

balances decreased by Rs205.

Item 5

No error has occurred in the control accounts. So, no double entry is required.

The memorandum purchases ledger requires an adjustment: the individual creditor

account need to be debited by Rs63. Thus, the total of credit balances in the purchases

ledger will be decreased by Rs63.

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Item 6

This is an error of original entry since the total sum of the purchase day book was

understated by Rs2,000. Thus, both the purchases account and the total creditors account

have been understated by Rs2,000.

Corrective entries: Dr Purchases account by Rs2,000 and Cr Total creditors account by

Rs2,000.

The memorandum purchases ledger requires NO adjustment since the March credit

purchases have been correctly posted to the various individual creditor accounts.

Item 7

Again, this is an error of original entry. Therefore, debit total creditors account and credit

total debtors account byRs2,004.

Purchase ledger Control account (or Total creditors account)

Rs Rs

Discount received (item 3) 1,715 Balance B/f (Net) 21,832

Total debtors account 2,004 Purchases a/c (Item 6) 2,000

Balance c/d (revised) (Net) 20,113

23,832 23,832

Balance b/d (net) 20,113

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Revised Total purchase ledger balances

Debit Credit Net Credit

Balances (1,012) 20,778 19,766

Item 4 205 205 410

Item 5 (63) (63)

(807) 20,920 20,113

1.9 SUMMARY

a) Control accounts are in-built accounting techniques which help in identifying

accounting errors. There are two types of control account, a Total debtors control

account and a total Creditors control account.

b) The balance on the control account should tally with the sum of individual

balances on the sales/purchases ledger. A control account sources its totals from

totals in the purchases/sales day books, analytical cash book and journal.

c) If control accounts are part of the double entry system, then the sales or purchases

ledger will be memorandum account. If the sales/purchases ledger form part of

the double entry system, then the control accounts will be memorandum accounts.

d) The procedure for correcting errors identified in the accounts involves three steps:

first, identify what entries, if any have been made in the accounts; second, identify

what entries should have been made; third, identify what entries are required to

correct the error.

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1.10 PRACTICE QUESTION

Practice questions on correction of errors

The trial balance of Happy Bookeeper Ltd as provided by its junior accountant includes

the following items:

Sales ledger control account Rs110,172

Purchase ledger control account Rs78,266

Suspense account (debit balance) Rs2,315

You have been given the following information:

(i) The sales ledger debit balances total Rs111,111 and the credit balances total

Rs1,234.

(ii) The purchase ledger credit balances total Rs77,777 and the debit balances total

Rs1,234.

(iii) The sales ledger includes a debit balance of Rs700 for business X, and the

purchase ledger includes a credit balance of Rs800 relating to the same business

X. Only the net amount will eventually be paid.

(iv) Included in the credit balance on the sales ledger is a balance of Rs600 in the

name of H. Smith. This arose because a sales invoice for Rs600 had earlier been

posted in error from the sales day book to the debit of the account of M. Smith in

the purchase ledger.

(v) An allowance of Rs300 against some damaged goods had been omitted from the

appropriate account in the sales ledger. This allowance had been included in the

control account.

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(vi) An invoice for Rs456 had been entered in the purchase day book as Rs654.

(vii) A cash receipt from a credit customer for Rs345 had been entered in the cash

book as Rs245.

(viii) The purchase day book had been overcast by Rs1,000.

(ix) The bank balance of Rs1,200 had been included in the trial balance, in error, as an

overdraft.

(x) The junior had been instructed to write off RS500 from customer's Y account as a

bad debt, and to reduce the provision for doubtful debts by Rs700. By mistake,

however, he had written off Rs700 from customer Y's account and increased the

provision for doubtful debts by Rs500.

(xi) The debit balance on the insurance account in the nominal ledger of Rs3,456 had

been included in the trial balance as Rs3,546.

Required:

(a) Draft journal entries to correct the above error.

(b) Establish the NET CORRECTED balances on:

(i) The sales ledger

(ii) The purchases ledger

(iii) The sales ledger control account

(iv) The purchase ledger control account

Unit 1DFA 1200

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