When an error is discovered in the accounting records, it should be corrected immediately to prevent the processing of wrong data which results to unreliable financial statements.
A correcting entry is a journal entry whose purpose is to rectify the effect of an incorrect entry previously made.
To illustrate how to prepare correcting entries, here are some examples.
On December 5, 2016, Gray Electronic Repair Services paid $370 registration and licensing fees for the business.
The correct entry is:
|Dec||5||Taxes and Licenses||370.00|
Suppose the bookkeeper, for whatever reason, debited Transportation Expense instead of Taxes and Licenses.
The entry made was:
Upon analysis, the Transportation Expense is overstated (higher than in should be) because the bookkeeper recorded transportation expense but it was not really a transportation expense.
Also, Taxes and Licenses is understated (lower than it should be). The amount should have been recorded but was not recorded under this account.
To correct these errors, we should make an entry to offset the effects. Transportation Expense is overstated therefore we should decrease it; Taxes and Licenses is understated therefore we should increase it.
The Cash account was credited in the entry made. Was the entry made to Cash correct? Look at the correct entry. Is it proper to have Cash credited? Yes. Therefore, we have no problem with the Cash account.
Now, to increase Taxes and Licenses, we credit it. To decrease Transportation Expense, we debit it. Remember that to increase/record an expense, we debit it; to decrease an expense, we credit it. The correcting entry would then be:
|Dec||31||Taxes and Licenses||370.00|
Note: The correcting entry is dated when the error is discovered. In this case, we assumed that it was discovered and corrected on December 31.
If an explanation or annotation is required, it would be something like: "To correct error made on taxes and licenses" or "To record correction of error on entry made for taxes and licenses."
After making this entry, Transportation Expense will zero-out ($370 debit and $370 credit) and Taxes and Licenses will now have a balance of $370.00, thus making our records correct.
Let us assume the bookkeeper made another error.
On December 17, the company collected a receivable from a customer, $1,650.00. Suppose the bookkeeper recorded it at $1,560.00 instead of $1,650.00. This was the entry made:
What is the correct entry? The entry should have been:
How will we correct this? Cash is understated because the accountant recorded $1,560 instead of $1,650. Accounts Receivable is also overstated because it was reduced by $1,560 only but should have been reduced by $1,650. We should then increase Cash and reduce Accounts Receivable by $90.
The correcting entry would be:
Another way of doing it (and an easier one) is to look at the entry made and correct entry. Upon analysis, you will see that the amount debited to Cash is less that what should have been debited. The same goes for the amount credited to Accounts Receivable. Cash should then be debited by $90 more and Accounts Receivable should be credited by $90 more.
Recap: Steps in Making Correcting Entries
The steps in preparing correcting entries may be summed up as follows:
- Determine the entry made. – What was the erroneous/wrong entry made?
- Determine the correct entry. – What entry should have been made?
- Analyze #1 and #2 to come up with the correcting entry.
Steps 1 and 2 may be interchanged. Nonetheless, you need to know the entry made and the correct entry (should-be entry) before you can come up with the correcting entry.