{m}.{s}.1The figures from the trial balance are used to prepare the profit and loss account and balance sheet. Therefore if there is something wrong in the trial balance, there must be correspondingly something wrong with either the profit and loss account or balance sheet (or both).
BALANCE SHEET | ||||
---|---|---|---|---|
CORRECT |
INCORRECT |
|||
ACCOUNT | DEBIT | CREDIT | DEBIT | CREDIT |
Sales | 2,725 | 2,725 | ||
Cost of sales | 1,500 | 1,500 | ||
Wages | 50 | 50 | ||
Rent | 400 | 400 | ||
Heat and light | 340 | 0 | ||
Post, tel, stat | 25 | 365 | ||
Fittings | 1,000 | 1,000 | ||
Stock | 0 | 3,375 | ||
Debtors | 2,050 | 2,050 | ||
Bank | 3,185 | 3,185 | ||
Loan | 2,000 | 2,000 | ||
Creditors | 840 | 840 | ||
Capital | 6,360 | 6,360 | ||
11,925 | 11,925 | 11,925 | 11,925 | |
[{m}.{s}a]
Now let's see how the figures change if the bill for £340 was entered as Postage, telephone and stationery instead of Heat and light (this misposting could easily be made in a manual or computer system).
The two accounts affected are both expense accounts which belong in the profit and loss. We will compare the profit and loss accounts prepared from the correct and incorrect trial balances.
We can see that total expenses are unchanged and the profit figure is therefore correct.
Profit and loss account: CORRECT | ||
Sales | 2,725 | |
Less Cost of sales | 1,500 | |
Gross profit | 1,225 | |
Less Expenses | ||
Wages | 50 | |
Rent | 400 | |
Heat and light | 340 | |
Post, tel, stat | 25 | |
815 | ||
NET PROFIT | 410 | |
Profit and loss account: INCORRECT | ||
Sales | 2,725 | |
Less Cost of sales | 1,500 | |
Gross profit | 1,225 | |
Less Expenses | ||
Wages | 50 | |
Rent | 400 | |
Heat and light | - | |
Post, tel, stat | 365 | |
815 | ||
NET PROFIT | 410 | |
The use of the profit and loss account, however, is not simply to calculate the profit but also to show how it has been derived. In that the expenses figures are now showing incorrectly, Mr Allen is getting the wrong information from the profit and loss account. He may now be trying to cut down on the use of the telephone etc... unnecessarily.
Let us now consider the result of a different misposting. Instead of debiting the £25 to Postage, telephone and stationery, it was debited to Fittings.
Profit and loss account: CORRECT | ||
Sales | 2,725 | |
Less Cost of sales | 1,500 | |
Gross profit | 1,225 | |
Less Expenses | ||
Wages | 50 | |
Rent | 400 | |
Heat and light | 340 | |
Post, tel, stat | 25 | |
815 | ||
NET PROFIT | 410 | |
Profit and loss account: INCORRECT | ||
Sales | 2,725 | |
Less Cost of sales | 1,500 | |
Gross profit | 1,225 | |
Less Expenses | ||
Wages | 50 | |
Rent | 400 | |
Heat and light | 340 | |
Post, tel, stat | -- | |
790 | ||
NET PROFIT | 435 | |
BALANCE SHEET | ||||
---|---|---|---|---|
CORRECT |
INCORRECT |
|||
ACCOUNT | DEBIT | CREDIT | DEBIT | CREDIT |
Sales | 2,725 | 2,725 | ||
Cost of sales | 1,500 | 1,500 | ||
Wages | 50 | 50 | ||
Rent | 400 | 400 | ||
Heat and light | 340 | 340 | ||
Post, tel, stat | 25 | 0 | ||
Fittings | 1,000 | 1,025 | ||
Stock | 3,375 | 3,375 | ||
Debtors | 2,050 | 2,050 | ||
Bank | 3,185 | 3,185 | ||
Loan | 2,000 | 2,000 | ||
Creditors | 840 | 840 | ||
Capital | 6,360 | 6,360 | ||
11,925 | 11,925 | 11,925 | 11,925 | |
The total expenses, and therefore also the net profit, showing in the profit and loss account are now incorrect. The profit figure is higher than it should be - the business looks more profitable than it really is.
This is a particularly bad type of error - getting the distinction between capital expenditure and revenue expenditure wrong thus producing the wrong figure for profit.
Note that the balance sheet will still balance as two figures are incorrect:
We will now look at the difference between capital expenditure and revenue expenditure.