Correct errors using journal entries and show the effect of corrections on profit

What this dot point is asking

SEAB wants you to correct errors by writing the journal entry that fixes them, and to show how each correction affects the profit. The central insight is that a correcting entry simply moves the figure from where it wrongly sits to where it belongs (or records what was missing), and you judge the profit effect by asking whether the error had touched an income or expense account.

The answer

The correcting journal entry

To correct an error, you write a journal entry that cancels the wrong effect and records the right one, with a narrative explaining the correction. The method:

1. State what the wrong entry did.
2. State what the correct entry should have been.
3. Write the journal entry that turns one into the other.

For example, if a van was wrongly debited to Purchases, you debit Equipment (where it belongs) and credit Purchases (to remove it).

Effect on profit

Profit is income minus expenses. A correction changes profit only if it touches an income or expense account:

So an error of principle like a van in Purchases changes profit (it had inflated expenses), but an error of commission between two expenses does not change profit (total expenses are unchanged).

Examples in context

Example 1. Capitalising a cost fixes the profit. A repair bill of \2,000$was correctly charged to expenses, but a$\$2\,000$ machine had been wrongly charged there too. Correcting only the machine (Debit Equipment, Credit Repairs) lifts profit by \2,000$and adds the asset, while the genuine repair stays as an expense. The narrative makes clear which$\$2\,000$ was moved.

Example 2. A reclassification that leaves profit alone. A clerk charged \300$ of advertising to the Rent account. Correcting it (Debit Advertising, Credit Rent) moves the cost between two expense accounts. Total expenses, and therefore profit, are unchanged; only the detail of which expense was incurred is now right.

Try this

Q1. Write the journal entry to correct equipment \1,500$ wrongly debited to Purchases. [2 marks]

• Cue. Debit Equipment \1,500$; Credit Purchases$\$1\,500$ (narrative: equipment wrongly debited to Purchases).

Q2. State the effect on profit of recording a sale of \400$ that had been omitted. [1 mark]

• Cue. Profit increases by \400$, because income was understated by the omitted sale.

Q3. A draft profit is \20,000$. A van$\$5\,000$ was debited to Purchases. State the corrected profit. [2 marks]

• Cue. Removing \5,000$from purchases raises profit, so corrected profit$= 20,000 + 5,000 = \$25\,000$.