CIMA - C2 Fundamentals of Financial Accounting
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240 16: Correction of errors ⏐ Part B Accounting systems and accounts preparation
Answer
B is correct.
Opening inventory is a debit, so omitting it puts $2,000 debit into suspense. Then, when cash was received from the
written off receivable the entries made were debits of $400 and credits of $800, putting another $400 debit into
suspense.
Chapter roundup
• It is not possible to draw up a complete list of all the errors which might be made by bookkeepers and accountants.
However, it is possible to describe five types of error which cover most of the errors as:
– Errors of transposition
– Errors of omission
– Errors of principle
– Errors of commission
– Compensating errors
• Errors which leave total debits and total credits in balance can be corrected by using journal entries.
• Errors which create an imbalance between debits and credits will need to be corrected by a suspense account entry.
When the error has been located it can be corrected by journal and the suspense account balance cleared. A suspense
account posting is always temporary.
• Suspense accounts are also used when a bookkeeper does not know in which account to post one side of a transaction.
Until the mystery is sorted out, the entry is recorded in a suspense account. A typical example is when the business
receives cash through the post from a source which cannot be determined. The double entry in the accounts would be a
debit in the cash book, and a credit to a suspense account.
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Part B Accounting systems and accounts preparation ⏐ 16: Correction of errors 241
Quick quiz
1 Which of the following is an error of principle?
A Recording the income from selling a non-current asset as a miscellaneous receipt in the income statement
B Petty cash expense $50 credited to expense and debited to petty cash
C Failing to record an invoice in the sales ledger
D Recording an inventory purchase invoice for $500 as
Dr purchases $500
Cr payables control a/c
2 A business incurred an expense costing $600. The expense was only entered in the cash account as a debit. Which of the
following journal entries is required to correct the error? (Assume a suspense account has been used to clear the
imbalance.)
A Dr Expense 600 Cr Bank 600
B Dr Suspense 600 Cr Bank 1,200
Dr Expense 600
C Dr Suspense 600 Cr Bank 600
D Dr Bank 1,200 Cr Suspense 600
Cr Expense 600
3 What is the function of a suspense account?
A A device used to enable the production of the financial statements, when required, despite the presence of errors.
B A method of ensuring the trial balance will agree.
C A way of focusing attention upon the corrective action required to ensure the trial balance does agree and the
integrity of the accounting system is maintained.
D A way of recording transactions when the ultimate accounting treatment required in unclear.
4 Correction of an error will only involve an entry to a suspense account if the original error __________
___________________________________________________________. (Complete the sentence.)
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242 16: Correction of errors ⏐ Part B Accounting systems and accounts preparation
Answers to quick quiz
1 A Correct, the sale of a non-current asset must not be confused with a revenue item – gross profit will be overstated.
B This is a reversal error.
C This is an error of omission.
D This entry has been correctly recorded, there is no error.
2 B Correct, it is necessary to correct the error and record the transactions hence the duplication of the $600 posting
to bank.
A Incorrect, you have not cleared the suspense account balance which will arise as a result of the incomplete but
incorrect entry.
C Incorrect, this will clear the suspense account but will not record the transaction.
D Incorrect, the entry is reversed.
3 C This is the correct answer.
A A suspense account can be used, expediently, to allow the production of accounts provided it is acknowledged
the accounts may be flawed.
B Opening a suspense account will ensure the trial balance agrees, but the function of a trial balance is to reveal
errors. The suspense account focuses attention upon those errors.
D Whilst suspense accounts are often used for this purpose, the transactions 'in suspense' must be journalised out
when the treatment has been clarified.
4 Correction of an error will only involve an entry to a suspense account if the original error prevented the trial balance
from balancing.
Now try the questions below from the Question Bank
Question numbers Page
68–74 404
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243
Part C
Final accounts and audit
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244
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245
Topic list Syllabus references
1 Preparation of final accounts D (1)
Preparation of sole
trader's accounts
Introduction
We have now reached our goal of preparing of the final accounts of a sole trader!
We will deal with the case of a trial balance and then making adjustments to produce final
accounts.
This chapter also acts as a review of what we have covered to date.
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246 17: Preparation of sole trader's accounts ⏐ Part C Final accounts and audit
1 Preparation of final accounts
You should now be able to prepare a set of final accounts for a sole trader from a trial balance after incorporating period
end adjustments for depreciation, inventory, prepayments, accruals, bad debts, and allowances for receivables.
1.1 Adjustments to accounts
This chapter acts as a consolidation of all the work you have done to date and is useful revision.
You should now use what you have learned to produce a solution to the following exercise, which involves preparing an
income statement and statement of financial position.
Question
Adjustment to accounts
The financial affairs of Newbegin Tools prior to the commencement of trading were as follows.
NEWBEGIN TOOLS
STATEMENT OF FINANCIAL POSITION AS AT 1 AUGUST 20X5
$
$
Non-current assets
Motor vehicle
2,000
Shop fittings
3,000
5,000
Current assets
Inventories
12,000
Cash
1,000
18,000
Capital
12,000
Current liabilities
Bank overdraft
2,000
Trade payables
4,000
6,000
18,000
At the end of six months the business had made the following transactions.
(a) Goods were purchased on credit at a list price of $10,000.
(b) Trade discount received was 2% on list price and there was a settlement discount received of 5% on settling
debts to suppliers of $8,000. These were the only payments to suppliers in the period.
(c) Closing inventories of goods were valued at $5,450.
(d) All sales were on credit and amounted to $27,250.
(e) Outstanding receivables balances at 31 January 20X6 amounted to $3,250 of which $250 were to be written off.
An allowance for receivables is to be made amounting to 2% of the remaining outstanding receivables.
(f) Cash payments were made in respect of the following expenses.
FA
S
T F
O
RWAR
D
Assessment
focus point
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Part C Final accounts and audit ⏐ 17: Preparation of sole trader's accounts 247
$
(i) Stationery, postage and wrapping 500
(ii) Telephone charges 200
(iii) Electricity 600
(iv) Cleaning and refreshments 150
(g) Cash drawings by the proprietor, Alf Newbegin, amounted to $6,000.
(h) The outstanding overdraft balance as at 1 August 20X5 was paid off. Interest charges and bank charges on the
overdraft amounted to $40.
Prepare the income statement of Newbegin Tools for the six months to 31 January 20X6 and a statement of financial
position as at that date. Ignore depreciation.
Answer
INCOME STATEMENT
FOR THE SIX MONTHS ENDED 31 JANUARY 20X6
$
$
Sales
27,250
Opening inventories
12,000
Purchases (note (a))
9,800
21,800
Less closing inventories
5,450
Cost of goods sold
16,350
Gross profit
10,900
Discounts received (note (b))
400
11,300
Electricity (note (c))
600
Stationery, postage and wrapping
500
Bad debts written off
250
Allowance for receivables (note (d))
60
Telephone charges
200
Cleaning and refreshments
150
Interest and bank charges
40
1,800
Net profit
9,500
Notes
(a) Purchases at cost $10,000 less 2% trade discount.
(b) 5% of $8,000 = $400.
(c) Expenses are grouped into sales and distribution expenses (here assumed to be electricity, stationery and
postage, bad debts and allowance for receivables) administration expenses (here assumed to be telephone
charges and cleaning) and finance charges.
(d) 2% of $3,000 = $60.
The preparation of a statement of financial position is not so easy, because we must calculate the value of payables and
cash in hand.
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248 17: Preparation of sole trader's accounts ⏐ Part C Final accounts and audit
(a) Payables as at 31 January 20X6
The amount owing to payables is the sum of the amount owing at the beginning of the period, plus the cost of
purchases during the period (net of all discounts), less the payments already made for purchases.
$
Payables as at 1 August 20X5
4,000
Add purchases during the period, net of trade discount
9,800
13,800
Less settlement discounts received
(400
)
13,400
Less payments to payables during the period*
(7,600
)
5,800
* $8,000 less cash discount of $400.
(b) Cash at bank and in hand at 31 January 20X6
You need to identify cash payments received and cash payments made.
$
(i)
Cash received from sales
Total sales in the period
27,250
Add receivables as at 1 August 20X5
0
27,250
Less unpaid debts as at 31 January 20X6
3,250
Cash received
24,000
(ii)
Cash paid
$
Trade payables (see (a))
7,600
Stationery, postage and wrapping
500
Telephone charges
200
Electricity
600
Cleaning and refreshments
150
Bank charges and interest
40
Bank overdraft repaid
2,000
Drawings by proprietor
6,000
17,090
Note. It is easy to forget some of these payments, especially drawings.
$
(iii)
Cash in hand at 1 August 20X5
1,000
Cash received in the period
24,000
25,000
Cash paid in the period
(17,090
)
Cash at bank and in hand as at 31 January 20X6
7,910
(c) When bad debts are written off, the value of outstanding receivables must be reduced by the amount written off.
Receivables in the statement of financial position will be valued at $3,250 less bad debts $250 and the allowance
for receivables of $60 – ie at $2,940.
(d) Non-current assets should be depreciated. However, in this exercise depreciation has been ignored.
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Part C Final accounts and audit ⏐ 17: Preparation of sole trader's accounts 249
NEWBEGIN TOOLS
STATEMENT OF FINANCIAL POSITION AS AT 31 JANUARY 20X6
$
$
Non-current assets
Motor vehicles
2,000
Shop fittings
3,000
5,000
Current assets
Inventories
5,450
Receivables, less allowance for receivables
2,940
Cash
7,910
16,300
21,300
Capital
Capital at 1 August 20X5
12,000
Net profit for the period
9,500
21,500
Less drawings
6,000
Capital at 31 January 20X6
15,500
Current liabilities
Trade payables
5,800
21,300
The bank overdraft has now been repaid and is therefore not shown.
1.2 Example: accounts preparation from a trial balance
The following trial balance was extracted from the ledger of Stephen Chee, a sole trader, as at 31 May 20X1 – the end of
his financial year.
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