An Error of Principle in Accounting occurs when an accounting transaction is recorded in a way that goes against the fundamental accounting principles.
An Example of Error of Principle in Accounting
Here’s an example to illustrate this type of error:
Let’s say a company purchases a piece of land for $100,000 that will be used for future expansion. However, instead of recording the transaction as a long-term asset in the Land account, an employee mistakenly records it as an expense in the Utilities account.
In this case, the error of principle occurs because the transaction is not recorded in accordance with the matching principle, which requires the recognition of expenses in the period they are incurred to generate revenue. The purchase of land does not represent a utility expense but rather a long-term investment. As a result, the financial statements will be misstated since the land purchase expense is not properly classified as a long-term asset.
How to correct this error?
To correct the error of principle, the transaction should be reversed in the Utilities account and recorded accurately in the Land account as a long-term asset.
Another Example of Error of Principle in Accounting
Let’s say a company receives a loan of $50,000 from a bank to finance the purchase of new equipment. However, instead of recording the loan as a liability in the Loans Payable account, an employee mistakenly records it as revenue in the Sales account.
In this case, the error of principle occurs because the transaction is not recorded in accordance with the revenue recognition principle, which states that revenue should be recognized when it is earned. The loan received from the bank is not revenue but a liability that needs to be repaid in the future.
How to correct this error?
To correct the error of principle, the transaction should be reversed in the Sales account and recorded accurately in the Loans Payable account as a liability. This ensures that the financial statements reflect the correct financial position of the company and comply with the fundamental accounting principles.
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