Your accounting system is the key to understanding what's happening in your business. It's also vital to tax return preparation and other government compliance regulations. That's why getting things right is essential.
Mistakes happen — even in buttoned-up accounting departments. Unfortunately, whether you use a cloud-based or desktop accounting system, mistakes can happen. 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.
Understanding what can go wrong and how it can impact your business is important. Even more important is knowing how to correct accounting errors and avoid future ones.
Here's what you need to know to reduce the number of errors that can creep into accounting systems.
What are the most common types of accounting errors & how do they occur?
1. Data entry errors
These small but impactful mistakes are among the most common accounting errors. Data entry errors typically occur when an employee mistypes numbers or enters a transaction into the incorrect account. The risk of this type of error is particularly heightened when there are high-volume accounts payable invoices. Some common data entry blunders include:
- Entering items in the wrong account.
- Transposing numbers.
- Leaving out or adding a digit or a decimal place.
- Omitting or duplicating an entry.
- Treating expenses as income or vice versa.
2. Error of Omission
An error of omission is simply a failure to record an item. It's not intentional; it's just overlooked. For example, an invoice is paid but you fail to note the receipt.
This can easily happen if you misplace documentation—a receipt or invoice—so that it never gets recorded.
This type of mistake can lead to duplicate payments if you don’t catch the oversight in time because payments might be remade to vendors who have already been paid but whose transactions were not recorded.
3. Duplication Errors
Duplication errors occur when the same transaction is recorded more than once. This often stems from poor visibility into financial processes or inadequate invoice receipt procedures. In AP, these errors could mean sending both a check and an electronic payment for a single invoice
Additionally, vendors may be listed twice in ERP systems due to mergers, acquisitions, or other shifts in an organizational structure. This mishap could result in teams not realizing that suppliers have already been paid for their services.
Duplicate payments can lead to financial discrepancies that waste resources, negatively impact vendor relationships, and cause inaccuracy in financial records.
4. Errors of commission
An error of commission is the mishandling of an item by putting it in the wrong place. The amount you enter is correct, and you even put it in the right general account, but you then use the incorrect sub-account. These errors can happen on both the accounts receivable (AR) and accounts payable sides.
For example, you receive payment on an invoice but note the receipt against a different customer's invoice. Your total payments come out right for accounting purposes, but what's shown for a particular customer is wrong.
5. Error of Transposition
An error of transposition is the incorrect recording of the amount of an item by reversing numbers. This can cause overstating or understanding the amount of an item, which is the result of transposing a number. For example, instead of entering an expense as $964, you erroneously enter it as $694. This produces $270. An error like this can be costly if it is a deductible amount that isn't claimed because of the entry error.
6. Compensating error
Compensating error is two errors that occur at the same time; one offsets the other. Because the net effect is zero, it is difficult to detect. For example, you erroneously overstate income by $2,000, but you also overstate an expense by a like amount so it all evens out even though both entries are wrong.
7. Error of principle
An error of principle is recording an item that does not comport with Generally Accepted Accounting Principles (GAAP). Usually, this happens when an entry is made in the wrong account. The amount is correct but is simply entered in the wrong place. An error of principle is a serious procedural mistake because it can have big consequences. The most common example of an error of principle is recording an owner's personal expense as a business expense.
8. Error of Entry Reversal
An error of entry reversal is the result of treating an expense as an item of income or vice versa. Instead of recording a $550 invoice in your accounts receivable, you erroneously put it in accounts payable (i.e., you record it as an expense).
9. Reconciliation Errors
Reconciliation errors are discovered when reconciling the accounting books. This type of error identifies a difference between what’s been recorded and the actual account balances.
How Can Accounting Errors Affect Your Business?
Accounting errors can distort your organization’s true financial position. Accounting errors may be minor or substantial. Either way, they can have serious consequences.
These inaccuracies impact decision-making, pose substantial risks of financial losses and even legal consequences due to noncompliance with financial reporting standards, and erode trust with vendors who rely on timely and accurate payments.
Further, accounting errors can cause problems with 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.
How to Prevent Accounting Errors
Being careful with your financial information is the first line of defense in ensuring that items are properly classified and entered correctly on your books
Preventing accounting errors is less about damage control and more about proactive management and the implementation of automated systems. This approach helps safeguard your financial operations against errors while enhancing your overall financial governance.
Here are some steps you can take to facilitate sound accounting entries.
1. Invest in Staff Training
Make sure employees who are entering expenses into your accounting system understand your accounts and descriptions. Take the time to fully explain your system. Some software may offer employee training, so take advantage of this option.
Set company policy on documentation procedures so entries can be made properly and accurately. For example, record reimbursements to employees when made after they've submitted expense reports so you know the numbers are correct.
And make sure there's someone knowledgeable in accounting entries who can answer questions when they arise.
2. Segregate Duties and Provide Adequate Review
Dividing responsibilities within the finance department is critical to ensuring no single individual controls all facets of a financial transaction. For example, one employee might be responsible for initiating purchase orders, another for receiving goods, and a third for handling payments.
This segregation minimizes the risk of error and also curtails opportunities for fraud. By implementing such checks and balances, each step of a transaction is validated independently, enhancing the accuracy and integrity of your financial data.
3. Don't Overload Your Employees
Employees who are overloaded with work can more easily make simple entry errors than if they were given adequate time to handle this activity. Yet it's essential that your accounting stays current and that you don't fall behind. Consider ways in which to simplify and improve data entry and avoid errors, such as the use of expense report software to easily import data into your accounting system.
4. Perform Timely Account Reconciliations
Regular reconciliations of accounts allow you to catch and correct errors as soon as they arise, which is crucial in maintaining financial accuracy and stability. Timely reconciliations are particularly important in your AP operations because the volume of transactions can obscure errors until they compound into larger discrepancies.
As a reminder, make sure that the individual responsible for payment reconciliation is not the same individual who authorizes the payments for those transactions.
5. Check for Differences Between the Budget and Actual Expenses
Use your accounting system to keep you on the right financial track. Your budget may show a certain amount of money is to be spent on a particular item or activity, but the entry doesn't match up. Comparing your actual expenses to the amount you budgeted can help you discover a misclassification (or at least an explanation for the differences).
6. Cloud-Based Document Storage
Using a cloud-based document management system can help you prevent accounting errors by maintaining a well-organized and secure archive of all financial transactions.
A cloud-based system allows employees to access documents from anywhere, streamlining data retrieval and ensuring documents are neither lost nor misfiled. This type of system also supports real-time updates and automatic backups, further enhancing accuracy and security in your financial record-keeping.
7. Implement Internal Controls
Put practices in place that can help to detect and correct accounting errors. For example, conduct bank reconciliations every month so you can catch a problem and the error doesn't linger on your books. The same goes for credit card statements. Review them monthly to ensure charges have been entered correctly in your accounting system.
8. Conduct a Periodic Professional Review of Accounts
You may want your accountant to periodically review your accounts to make sure that they appropriately reflect the expenses you incur and comply with GAAP. Your accounting software may have a feature that facilitates a client data review by your accountant.
9. Adopt Best Accounting Practices and Standards
Don't let your staff procrastinate. Set deadlines for data entry and reconciliation so that errors are found quickly and can easily be corrected.
Understand accounting standards, so they are incorporated into your accounting system. Private companies based in the U.S. use GAAP for accounting. This dictates when and how income and expenses are reported. Your accounting system must reflect these standards.
Mitigating Accounting Errors – Outsourcing Your Key Accounting Tasks
Preventing accounting errors requires a blend of strategic oversight, stringent internal controls, and the automation of key financial functions. By understanding the types and sources of common errors, you can implement targeted measures to mitigate them.
You didn’t start your business to spend hours working on your bookkeeping and accounts. Why not outsource your key accounting tasks to us and put those hours back into your business? At Filing Taxes, we help you separate personal and business finances, set up efficient bookkeeping, recommend expense management tools, act as your tax agent, and provide reporting and advice for informed decision-making.
Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.