Mistakes happen — even in buttoned-up accounting departments. Despite everyone's best efforts, errors can (and do) make their way into accounting processes and cause all sorts of havoc. A transposed digit can throw debits and credits noticeably out of balance, or a reversed entry can cause an imperceptible error to casual readers. That's why it's important to have a plan in place to detect, minimize and fix mistakes. Error prevention may be a loftier, even impractical, objective given the human element involved, though the right accounting software controls can help.
Here's what you need to know to reduce the number of errors that can creep into accounting systems.
What Is an Accounting Error?
Let's start with what's not an accounting error: fraud. Fraud is the purposeful manipulation of accounting information. It's illegal and unethical, but it's not an "error."
Accounting errors are unintended accidents; they are the result of an inadvertent mistake. Sometimes accounting errors are caused by a slip of the hand, like transposing a number or hitting an incorrect key. Other times they stem from a misunderstanding of accounting rules or company policy. Nevertheless, any accounting department worth its salt aims to limit errors in its accounting data, especially data that flows into financial reporting used by internal and external stakeholders. Errors can be embarrassing at best, misleading at worst.
- Accounting errors are unavoidable but can be minimized.
- Common accounting errors arise from faulty data entry, omission errors, commission errors and errors in principle.
- Accounting errors undermine company credibility, waste resources and hamper the reliability of information needed for business decision-making.
- Combining preventive and detective controls with accounting software can reduce the likelihood of errors.
Types of Accounting Errors
There are two broad categories of accounting errors — those that affect the trial balance and are easily detected and those that don't obviously throw off the balance, requiring a closer look. The trial balance is an accounting report, run during the financial close process, that shows the ending debit or credit balance for every account in a company's general ledger. The trial balance should show the sum of debit and credit balances in equal amounts, though not necessarily individual debit and credit balances.
- Errors that cause the trial balance to clearly be out of balance. For example, recording an unbalanced journal entry or a single-entry journal entry can cause the overall trial balance to be incorrect. These basic errors are typically caught by accounting software controls that prevent transactions with unequal debits and credits from being recorded in the first place.
- Errors that do not have an obvious impact on a trial balance can still cause problems. For example, a transaction might be recorded twice or entered in incorrect general ledger accounts, yet be undetectable in a trial balance because the debits and credits will still appear equal. In fact, most accounting errors do not cause the trial balance to be unbalanced and therefore must be identified using other control mechanisms.
|Impact the Trial Balance||No Trial Balance Impact|
|Single entry accounting||Duplicate entries|
|Unbalanced journal entries||Omitted transactions|
|Incorrect values: transposed, misplaced decimals, typos|
|Incorrect general ledger accounts|
|Incorrect accounting treatment|
How Do Accounting Errors Impact Businesses?
Accounting is the language of business, and accounting errors create miscommunication. If the underlying accounting data is incorrect, the stakeholders who rely on it are more likely to make a misinformed decision. For example, an accounting error can cause a business manager to make a suboptimal operating decision, especially harmful in cases where profit margins are thin or cash flow is tight. Similarly, external lenders might be relying on inaccurate financial statements when making lending decisions.
Accounting errors can lead to strained relationships with suppliers and customers if transactions are handled incorrectly or missed entirely. They can also undermine business credibility. Additionally, accounting errors take time to correct, making staff less efficient, and can cause labor costs to increase.
Further, accounting errors can cause problems with compliance reporting, such as financial statements, debt covenants and tax filings, which, in turn, can trigger audits, penalties and fines.
For these reasons, it's important to reduce the occurrence of errors and increase the ability to detect them when they arise. Errors should be fixed as soon as they are discovered to mitigate a snowballing negative impact on the business.
4 Common Accounting Errors
Accounting errors that are evident on a trial balance are easy to identify and fix as part of the accounting close. But for the majority of accounting errors — those that are undetectable at the trial balance level — more effort is required. For this reason, it's important to put processes in place to detect these four common accounting errors:
- Data entry errors. These are basic accounting mistakes. Data entry errors include transposed numbers, typos and other (often manual) slipups, like a misplaced decimal.
- Errors of commission. This category of errors arises from an incorrect action — for example, a transaction is recorded but some part of it is wrong, such as using an incorrect general ledger account number or using a miscalculated or improperly rounded value. Reversed entries, where debits and credits are improperly switched, and duplicated entries are also errors of commission.
- Errors of omission. These errors happen when a transaction is overlooked and not recorded. It's simply left out of the accounting records.
- Errors of principle. Errors of principle occur when the wrong accounting treatment is applied to a transaction. Errors of principle are significant technical accounting errors, as the resultant transaction will not be in accordance with Generally Accepted Accounting Principles (GAAP), either because the wrong guidance was followed or because it was followed incorrectly.
It's especially tricky to find accounting errors that compensate for each other. Sometimes these errors manage to unintentionally offset each other, masking the underlying mistake. For example, lease expenses for two identical company cars can be duplicated in one department and omitted in another, making totals appear accurate even though individual departmental costs (and associated key performance indicators) are incorrect.
6 Ways to Prevent Accounting Errors
As the saying goes, an ounce of prevention is worth a pound of cure. When it comes to accounting, the most effective accounting departments have control procedures in place that aim to do both. There are two types of controls: Preventive controls are designed to block errors from occurring to keep financial data clean before it flows into financial reporting that goes to stakeholders. Detective controls identify errors or irregularities for investigation and correction after they are recorded. It's important that the curative detective controls be performed regularly so that accounting errors are caught quickly.
Following are examples of preventive and detective controls that serve to minimize accounting errors.
- Use accounting software that includes error-reducing features, such as the ability to block lopsided transactions that would impact the trial balance. Choose a product with the highest level of automation and systems integration; this will minimize the need for excessive manual intervention, which is how many data entry errors are introduced. NetSuite Cloud Accounting Software includes tools that consistently apply specified standards and policies to limit errors of commission and errors of principle.
- Invest in staff by training them properly, providing adequate resources and ensuring manageable workloads. Overstretched accounting departments are more likely to generate accounting errors.
- Segregate duties and provide adequate review to help minimize errors. These controls go hand-in-hand. By having a separate set of eyes review another person's work product, errors can often be flagged at the front end of the accounting process. Since this can be challenging for companies with a small staff or where the owner does it all, consider using an outside accountant to review accounts periodically.
- Stay organized with proper record-keeping to reduce the likelihood of overlooking accounting transactions that produce errors of omission. Properly organized records are also required in the event of a tax audit.
- Perform timely account reconciliations to compare accounting balances with external sources, such as bank statements, loan statements and credit card statements. Reconciliations can also apply to comparisons of subsidiary journals (that is, special chronological records of frequently occurring transactions, such as an accounts receivable subsidiary journal) to the general ledger, although this step can usually be eliminated by using integrated accounting software.
- Compare actual balances to budgeted balances to highlight variances. By analyzing variances that seem unreasonable, accounting errors can be discovered. For example, duplicated entries might create larger-than-expected balances, while omitted transactions may result in smaller account balances than might make sense. A similar procedure can be performed using actual balances from the current year versus the prior year or with regard to key performance indicators.
Accurate accounting information is critical for business management. While there is no ironclad way to eliminate all accounting errors, processes and controls can be put into place to help minimize their occurrence. Understanding how common accounting errors arise and where to look for them are important first steps. Using automated integrated software, together with an assortment of preventive and detective controls, can create a less error-prone accounting environment.
Accounting Errors FAQs
What are common accounting errors?
Accounting errors are unintentional mistakes that can originate in a number of ways. Commonly, they involve recording a transaction incorrectly because of a data-entry mishap. Sometimes transactions are missed entirely or are simply recorded in the wrong subsidiary journal. Less often, but more important, accounting errors may be the result of using the wrong accounting standard or misapplying that standard.
How do you identify accounting errors?
A strong framework of preventive and detective controls, together with suitable accounting software, can be the most effective way to find accounting errors.
What are the various types of errors in accounting? Explain with examples.
Accounting errors are broadly described as those that either cause a clear imbalance in the sum totals of debit and credit balances and errors that don't. The most obvious errors impact the trial balance, causing debits to be out of balance with credits. Errors that don't impact the trial balance can be more difficult to detect. They include data entry errors, such as typos; errors of commission, such as using the wrong general ledger account number; errors of omission, such as neglecting to record a transaction; and errors in principle, such as recording a purchase as an expense rather than an asset.
What are the 4 types of accounting errors?
Most accounting errors can be classified as data entry errors, errors of commission, errors of omission and errors in principle. Of the four, errors in principle are the most technical type of error and can cause the resultant financial data to be noncompliant with Generally Accepted Accounting Principles (GAAP).