What is an Accounting Error?
An accounting error is a mistake made in financial accounting that is not fraudulent in nature. These innocent mistakes can be greatly reduced by using accountants who are familiar with accounting procedure and the financial position of a given individual or company. When a mistake of this type is identified, it must be corrected as soon as possible.
Some accounting errors are errors of omission, in which something is left out of an accounting statement by mistake. Many people balancing their checkbooks have noted the consequences of an error of omission when they forget to log a transaction and overdraw their accounts or cannot get their books to balance. A transaction may not be recorded or may be recorded in the wrong place, leading to an omission on an accounting statement which creates a discrepancy.
Errors of commission involve data that is recorded or calculated inaccurately. For example, an accountant might transpose numbers, add instead of subtracting, or make a similar mistake in accounting. Bad calculations were a common accounting error historically, although the use of software has greatly reduced such errors. Accounting software calculates automatically, so as long as a transaction is entered properly, there should be no math mistakes.
Finally, in an error of principle, the principles of accounting procedure are applied improperly or negligently. There are a series of standard accounting practices that people are supposed to use in handling financial accounts, and these generally accepted accounting principles (GAAP) must be followed by all accountants. Accountants who do not apply these procedures properly can create accounting errors that will result in discrepancies on financial statements.
Once an accounting error is recognized, steps are taken to identify why it has occurred. Then, the error can be corrected. It is also important to address the cause to reduce the risk of a repeat error. For example, if an accounting principle was not followed, the accountant knows to follow this principle in the future. In addition, the accountant could be held liable in the future for failing to comply with procedure.
Sometimes it is hard to distinguish between a genuine accounting error and fraud. An auditor investigating a case may come up with information that can be used to find out whether an accountant made an innocent mistake or was attempting to commit fraud. For example, an audit may find that an accountant knew about an accounting error and took no action, which would suggest that fraud may have been involved.
@Azuza - I think at least sometimes it's easy to tell if something is fraud or not. The example the article gave of transposed numbers is a good example of something that was clearly a mistake.
Either way though, I would have to be the person making that accounting error! I know in the insurance industry we have a type of insurance called "Errors and Omissions" which kicks in if we make a mistake with someones policy. I don't think they have anything like that in the accounting world, but it sounds like they totally should!
Man, I would hate to be an auditor. I can't imagine being the one to decide whether something was an error or outright fraud!
As the article said, the two can look pretty similar at first glance. Also, you can never really know what someone is thinking. I would just hate to accuse an innocent person of fraud, you know?
@chivebasil - Unfortunately that sounds like a pretty familiar story. The history of business is filled with colossal accounting errors often with huge consequences.
A lot of readers will remember the collapse of the energy giant Enron at the beginning of the 2000s. A big part of their trouble (and trust me, they had a lot of troubles) was bad accounting on the part of their auditing firm, Arthur Anderson. Some of this amounted to erroneous accounting and some of it amounted to fraud.
Either way, when the ship started sinking at Enron it didn't help anything that they had a lot of accounting data they couldn't rely on. Nobody really knew what the state of the company was. Good accounting is the foundation of any successful business. Without reliable numbers you are just playing a guessing game.
Accounting errors might seem like just little typos but they can have serious consequences for a business. I once worked in an office complex and I became good friends with some guys that worked for a company based a few floors below me.
Apparently they relied on an independent accounting firm to handle all their finances. I don't know much about the accounting firm but they must not have been one of the better ones. They made a huge mistake when they were filing the taxes for this company. The details would take a long time to explain but they basically underpaid these guys tax bill by hundreds of thousands of dollars.
Well, of course the mistake got noticed and the company got audited. The audit turned up lots of other problems, involved lots of lawyers and a very long drawn out process. It ended up being the beginning of the end for those guys. Within two years the company was completely dissolved.
All of their problems were not because of the accounting error but that was the start of the trouble. I feel bad for those guys. They were good people even if they didn't know how to run a company.
@Charred - A friend of mine works as an accountant. He told me one of the most frequent errors in accounting is confusing expenses for assets. I suppose this would be an error of principle.
If you buy goods for your business they should usually be treated as expenses. If however you place them in the asset column, then you have immediately misrepresented your profits and total capitalization. He said beginning accountants sometimes make this error.
I think in the case of balancing my checkbook my errors of omission have had more to do with bank fees than anything else.
I don’t usually enter bank fees into my total balances – but the bank does. There’s no way I can keep up with them sometimes. I think there’s a maintenance fee and an ATM withdrawal fee, among others from time to time.
Because of this we never completely match, but we’re not wide apart in our totals either.
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