Compensating Errors: Definition
When an already-committed error is offset by another error (or set of errors), the latter error is known as a compensating error. Compensating errors occur when errors in equal amount but opposite in sense cancel each other.
When errors have been compensated, the trial balance is in agreement. The result is that locating such errors becomes difficult.
Compensating errors pose greater problems to a business compared to other types of errors. This is because they are not single errors but are combinations of more than one error.
For this reason, to correct compensating errors, it is necessary to identify not one error but more than one error (or a number of errors).
For example, consider that advertising charges of $1,000 are debited in the advertising account as $1,500. Also, the interest received of $2,000 is credited in the interest account as $2,500.
Then the excess debit of $500 in the advertising account is set off against the excess credit in the interest account. As the excess debit is compensated with the excess credit, the trial balance does not reveal the errors.
It is also possible for two or more errors of this kind to be made in the books, which cancel out each other’s effects.
For example, if both the sales book and purchases book are overcast by $1,000, the net effect in the ledger will be nil. This is because the over-debit in the purchases account is nullified by the over-credit in the sales account.
To correct compensating errors, each error must be corrected individually.
The trial balance extracted on 31 December 2017 from the books of a wholesaler does not agree, and so the difference was allocated to a suspense account.
The trial balance totals were Dr. $213,820 and Cr. $212,230. Later, the following errors were discovered:
- An invoice for $620 issued to Levis was recorded in the sales book as $1,620 and posted to the ledger accordingly.
- Returns inward book was overcast by $100.
- A credit note for $550, received from Sydney Traders, was recorded correctly in the appropriate subsidiary book but posted to the credit of Sydney Traders account.
- A cheque for $1,780, received from Harry, was entered in the cash book but not posted to his personal account in the ledger.
- A credit purchase of an office machine for $1,250 was journalized through the purchases book. This means that it was treated as a purchase of goods instead of an asset.
- A purchase of goods for $5,340 from Melbourne Wholesalers was recorded correctly in the purchases book but posted to their account in the ledger as $5,430.
- Goods costing $950 were taken by the owner for their personal use but no corresponding entry was made in the books.
- There was a mistake in balancing the salaries account. Its balance was shown as Dr. $16,230 instead of the correct balance of Dr. $15,330.
Required: Rectify the entries in the journal and suspense account, ensuring that they are duly balanced.
Note: The total for the Dr. side ($213,820) of the trial balance exceeded the Cr. side total ($212,230) by $1,590. Therefore, the opening entry in the suspense account was made at $1,590 on the Cr. side, bringing the total credit equal to the total debit.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.