Modern technology has made accounting easier than ever before. However, accounting mistakes are still common; they can cost you money and even threaten the survival of your business. In order to avoid making accountancy errors, first it’s important to understand what types of accounting errors there are.
Types of accounting errors
Types of accounting error include:
Errors of omission
An error of omission occurs when a transaction is not recorded in the appropriate financial reports, whether by mistake or intentionally.
Errors of commission
An error of commission involves a transaction that has been recorded incorrectly, for example, subtracting a figure which should have been added.
Errors of principle
An error of principle, also known as an input error, relates to transactions which do not comply with generally accepted accounting principles (GAAP), the collection of commonly-followed rules for financial reporting. Please note, GAAP does not have a universal standard and will vary between regions and industries.
A transposition error is when multiple digits are recorded in the wrong sequence, whether as an individual figure or as part of a greater one. These errors can occur very easily and are usually unintentional. However, they can lead to additional miscalculations further down the line.
A rounding error is exactly what it sounds like, it occurs when a number is changed to one with fewer decimals. In most cases, rounding errors are not a huge issue but can potentially lead to further resulting errors.
Errors of entry reversal
A reversal of entries error occurs when entries are, for example, credited to one party and debited from another.
What happens if I make an accounting error?
Accounting errors can occur both intentionally and by accident. Intentional errors are a serious matter and anyone found to have committed an intentional accounting error is at risk of criminal prosecution. In these cases, the intention behind the error will be investigated in depth to determine whether charges need to be brought, e.g. for fraud or money laundering.
Accidental errors tend to be honest mistakes due to input errors, and businesses can take several steps to prevent them from occurring.
How to avoid accounting errors
Here are some simple steps you can take to prevent various different types of errors being made:
It sounds obvious, but it’s surprising how many business owners forget to record the small transactions. No matter how big or small your company, and no matter how insignificant those cash purchases seem, it’s vital to make note of them all. Forgetting transactions here and there can become a bad habit, potentially leading to your balance sheet being skewed. Get into the habit of being thorough and force yourself to record every single penny you spend.
Always set a budget
What happens when you go food shopping and don’t take a list? You end up buying items you don’t need and spending more money than anticipated! The same principle applies to accounting. You should set a budget for every project. This way you establish how much it should cost before you start. Without a budget, it’s tempting to keep spending that little bit more on a project to make it work, and this can lead to costs spiralling out of control. A budget keeps you disciplined.
Checking that the number in your account matches the total amount you’ve actually spent is something else you should be doing regularly. If you’ve followed our first piece of advice, then your accounts are likely to be accurate anyway, but reconciliation is a useful error correction procedure that you shouldn’t neglect. Accurate statements prevent poor business decisions being made.
Appoint someone who knows what they’re doing
Many small business owners take on accounting themselves in addition to all their other duties. While this might seem a good way to save money, it’s not always the best option. Accounting is time-consuming and not everyone has a knack for it. Appointing a professional ensures a higher level of accuracy and let you focus on other areas of your business.
Keep your personal and business accounts separate
Forgetting to set up a separate business account is another typical error. You don’t want important business transactions mixed up with your grocery shopping. Keep them separate and it makes balancing accounts far easier.
Make use of technology
As we said at the start of this post, technology means accounting is easier than ever before. Yet many business owners are put off by their lack of knowledge of accounting software and stick to more laborious traditional methods. You don’t have to invest in the most expensive, most complicated, most sophisticated piece of software. Nevertheless, you should learn how to use accounting software (perhaps with a free trial) and use it to your advantage. Find out more about cloud accounting software.
Know the difference between profits and cash flow
Whenever you close a deal, your natural instinct might be to record the income in your accounts straight away. However, be careful! All that profit doesn’t become cash in hand for you to spend straight away. Not being aware of the difference between profits and cash flow can make your business seem healthier than it really is and leads to overstatement.
What to do if you’ve made an accounting error
If you discover an accounting error, you should make a correcting entry to ensure your books are accurate. If a correcting error is necessary, you should identify all accounts which are affected by the original error and ascertain how much needs to be adjusted. Then you should make a new entry for the correction, in the same accounts as the original posting.
Accounting errors here and there will inevitably happen at some point. However, you can avoid significant accounting mistakes simply by establishing good habits and being thorough. Good practices applied consistently will have positive outcomes for your business.
If you’d like help or advice with your accounting, contact WKM Accountancy today.