Types of Errors in Small Business Accounting

Common Accounting Errors and How To Avoid Them

Small business owner with laptop and calculator frustrated by paperwork
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A small business can make certain types of accounting errors—many of which are genuine mistakes, usually mathematical, and made in good faith. 

Whether inadvertent omissions, inadvertent duplicates, or something more complex, accounting errors made by bookkeepers are important to spot and correct.

Key Takeaways

  • Some common types of accounting errors include errors of omission, commission, reversal, duplication, principle, and original entry. 
  • If you use accounting software or an accounting information system in your business, don’t rely on it completely. It is only as good as the information that was entered into it.
  • Keep an accountant on retainer to check over and sign off on your accounting records at the end of every accounting period.
  • Several different types of accounting errors are genuine mistakes. Don’t automatically think an error is fraudulent.
  • Understand what accounting errors you can and can’t correct.

Common Errors in Small Business Accounting

Accounting errors in your small business are often simple bookkeeping mistakes that are of little consequence to your business. Some may not even affect your financial statements at all. Other types of errors, however, can indeed have an impact on your financial statements and even your decision-making as a business owner. These types of errors require a lot of time and business resources to find and correct. Here are some common ones to look out for.

Error of Duplication

If you make an error of duplication, it will likely be recording a debit or a credit twice in the bookkeeping process. Making an error of duplication is easily done if more than one person enters data. It also happens if more than one invoice is requesting payment. If the amount of the duplicate entry is substantial, it can have serious implications for the business. Income or expenses could be vastly overstated or understated on the income statement.

Error of Omission

An error of omission occurs when you fail to enter a financial transaction in your books. You may not even realize you have made this error but it could understate your income, overstate your income, or affect your balance sheet. When an error of omission occurs in the accounting process, it can affect the trial balance, which is the report of all the accounts in the general ledger that have balances.

Misplacing a receipt or invoice so that it never gets recorded is one example of an error of omission.

Error of Commission

An error of commission is the result of mishandling an item by entering it in the wrong place. Examples include posting an accounts receivable to an accounts payable account or applying one customer’s payment to another’s invoice. This type of error can significantly affect either the income statement or the balance sheet. It can also impair the capital position of the firm, which is a serious unintended consequence.

Error of Original Entry

An error of original entry is the process of incorrect information being entered into the accounting books when an item is first posted. Each entry should be backed up by some sort of receipt. When the original entry of this type of item is made, the bookkeeper may transpose two numbers. This leads to the error of original entry, which can have a major impact, as the wrong amount would be reflected in any other accounts related to the transaction.

Compensating Error

A compensating error in accounting occurs when an error in one account is balanced out by an error in another account. One example might be an incorrect entry in the inventory account and a corresponding entry in accounts payable and both are wrong. Compensating errors do not affect the trial balance since they are equal and opposite—and also incorrect. 

Error of Principle

An error of principle occurs when an accounting error is made on both sides of the transaction. However, it is often made because the person recording the transaction may not have a thorough understanding of accounting principles. For example, an equipment purchase, which is a fixed asset purchase or capital expenditure, is entered as an operating (or day-to-day) expense. 

An error of principle does not affect the trial balance. A bookkeeper may find it when matching receipts to the books.

Error of Entry Reversal

Reversing entries are often a practice that occurs at the end of the accounting period. For example, a credit such as the cost of goods sold has been posted as a debit, or an invoice is posted in accounts payable instead of accounts receivable.

Practical Tips To Prevent Business Accounting Errors

Accounting errors can be prevented in several ways, but one priority for your business should be to maintain solid internal controls. Be sure whoever is inputting your data is an accurate typist. This covers many possible solutions for controlling business accounting errors. The person responsible for data entry, meanwhile, should be cautious about transposing a number. They should understand financial statements and which entries go into which accounts. They should also guard against omitting or duplicating an entry in the books, which should be audited regularly.

Doing Accounting In-House

Small businesses may use accounting software and accounting information systems to do their accounting for them. While this can streamline the bookkeeping process, it can be helpful to also at least keep an accountant on retainer.

To keep your finances in check, take your accounting records to a contracted accountant once every quarter. They review the bookkeeping records at the end of each accounting period and make any necessary adjustments. This strategy can save you money in the long run.

Compare Your Business Bank Accounts and Books

The bookkeeper can compare the business’s bank accounts to its accounting ledgers and correct any errors before the books go to the accountant.

Don’t Forget Small Transactions

Bookkeepers should keep track of all financial transactions, no matter how small. For example, the petty cash account, if you have one, has to be accounted for at the end of every accounting period.

Assign Budgets to All Projects

By assigning budgets to projects and sticking to them, small businesses can understand their costs better. It’s important to have a budget for all projects since a budget is your roadmap regarding the project. If you have budgets set for all your projects, costs should become clearer to you.

Correcting Errors in Accounting

The Financial Accounting Standards Board (FASB) specifies that accountants can make the following corrections:

  • Changing the accounting principle
  • Changing the accounting estimate
  • Changing the reporting entity
  • Correcting an error in previously issued financial statements

Certain accounting errors may also require accountants to draft a restatement, which is a revision and re-release of prior financial statements. These errors include:

  • Miscalculating an expense
  • Not depreciating an asset
  • Miscounting inventory
  • Making a mistake in the application of accounting principles
  • Making an oversight

Frequently Asked Questions (FAQs)

How do you identify errors in accounting?

You can take these steps to identify errors in accounting: 

  • Keep an audit trail: An audit trail is a set of security documents that record the transactions that you record in your books.
  • Have good internal controls: Have a process in place that steers you in the right direction regarding your accounting function.
  • Double- and triple-check your work: Anyone can make a mistake. Check your receipts against your journal entries. Check the format of your accounting entries if you use double-entry bookkeeping. Reconcile your bank statements and compare them to your accounting records. Have someone help you go through this process for even more accuracy. 

What are the penalties for errors in small business accounting?

You may face IRS penalties if a tax preparer calculates your business’s taxes incorrectly. Tax penalties vary based on the amount of underpayment of taxes. Typically, for tax preparers, the penalty is $1,000 plus 50% of the income to be derived for each error on the return. The IRS may waive those penalties, though, if no harm was intended.