Even with automation and easy-to-use accounting tools, bookkeeping mistakes can happen. Journal entry errors can end up costing your small business time and money. Learn how to get your books back on track with correcting entries.
What is a correcting entry?
A correcting entry in accounting fixes a mistake posted in your books. For example, you might enter the wrong amount for a transaction or post an entry in the wrong account. You must make correcting journal entries as soon as you find an error. Correcting entries ensure that your financial records are accurate.
With correcting entries, you adjust the beginning of an accounting period’s retained earnings. Retained earnings include your take-home money after paying expenses for the period. These kinds of entries are called prior period adjustments.
Accrual accounting and double-entry recordkeeping
For every transaction your business makes, you must make debit and credit entries. Some accounts increase with a debit, while others increase with a credit. And, some accounts decrease with a debit, while others decrease with a credit.
Debit and credit entries are equal but opposite. The total debits and credits in your books should equal each other. Unequal debits and credits are a good indication that there is a mistake in your records. Use debits and credits for correcting journal entries.
How to rectify errors in accounting
Sometimes, mistakes happen in your accounting records that need to be corrected. You need to identify several details before making a correcting entry, including the type of mistake and the number of accounting periods it affects.
Some accounting errors do not require a correcting entry because they are counterbalanced. A counterbalancing error happens when one mistake cancels out another mistake.
You must make a correcting entry if you discover you’ve made a categorizing or mathematical error. If you originally posted to the wrong account, you might need to adjust the entire entry. Or, you might have to make a minor adjustment.
If you need to make a correcting entry, do the following:
- Find out all the accounts that are affected by the error.
- Determine the amount that needs to be adjusted.
You must make new entries for the correction. Use the same accounts as the original posting for the correcting entry.
Accounting error correction entries
Depending on the kind of error, you will use one of the following methods to correct it:
- Make a single journal entry that fixes the error when combined with the incorrect entry
- Reverse the incorrect entry and use a second entry to record the transaction
Usually, adjustments can be made when you record the wrong amount. Reversals are often used when you record an entry in the wrong account.
Correcting entries with adjustments
To adjust an entry, find the difference between the correct amount and the error posted in your books. Enter the difference (adjustment amount) in the correct account(s).
If the original entry was too low, increase an account. If the original entry was too high, decrease an account.
Correcting entries with reversals
Reversal entries cancel out the original erroneous postings. You then create new entries with the correct information.
To reverse an entry, credit the account that received the debit in the original entry. And, debit the account that received the credit. Use the same amounts as the original entries.
Correcting journal entry examples
Take a look at these correcting journal entry examples.
Example 1: Making adjustments
Let’s say you collected $200 on a receivable from a customer. You should debit the cash account (increasing it) and credit the accounts receivable (decreasing it). Your journal should look like this:
But, you enter $150 instead of $200, so your journal is actually recorded like this:
To fix the entries, find the difference between the correct amount and the mistaken entry. In this example, the difference is $50. Debit the additional $50 to the cash account and credit $50 to the accounts receivable account.
The correcting entries combined with the original erroneous entries reflect the correct amount ($150 + $50 = $200).
Example 2: Reversing entries
Let’s say you bought a new piece of equipment for $2,000. You should debit the equipment expense account $2,000 (increasing it) and credit the cash account $2,000 (decreasing it). Your journal should look like this:
But, you make an entry in the tax expense account instead of the equipment expense account. Your journal is actually recorded like this:
Again, you need to correct the mistake in your books. To fix the entries, you must offset the original general ledger entries.
The equipment expense account is lower than it should be, so you need to increase it with a debit. The tax expense account is higher than it should be, so you need to decrease it with a credit. The cash account is not affected. Here is what the correcting entries look like:
Now, your books reflect the amount spent on the correct expense account.
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This article has been updated from its original publication date of October 31, 2017.This is not intended as legal advice; for more information, please click here.