Compensating errors

Definition and explanation

Compensating errors are two or more accounting errors that collectively cancel their net numerical impact with one another, keeping the debit and credit totals of the trial balance in agreement. For instance, an excess credit in the sales account may be compensated by an excess debit of the equal amount in the accounts receivable account. In this situation, both errors would compensate each other, keeping the amounts of total debits and total credits equal. Similarly, a less debit in the purchases account may be balanced by a less credit in the accounts payable account, and vice versa.

Compensating errors may happen within the same account or in two or more different accounts. Like other accounting errors, they disturb the balances of individual ledger accounts in which they appear but don’t cause a discrepancy in the trial balance. Since the net numerical effect of these errors is zero, they can be more difficult to notice and rectify compared to non-compensating errors.

Rectification of compensating errors

Compensating errors can be exceedingly difficult to spot unless their presence in the accounting records is clearly known. Since one error is compensated by one or multiple other errors, compensating errors always exist in combination. The bookkeeper or accountant needs to identify individual wrong entries that compensate each other. The correction of compensating errors is, therefore, a more challenging task compared to other types of accounting errors.

Examples

Example 1 – excess debit in one account is compensated by excess credit in another account

The merchandise amounting to $10,000 sold to Mr. John is wrongly debited to his account as $1,000 only. At the same time, $10,000 cash received from Mr. Steward is wrongly credited to his account as $1,000 only. The first error will reduce the total debits by $9,000, whereas the second error will reduce the total credits by $9,000. Both are compensating errors because they will nullify the effect of each other, keeping the debit and credit totals of the trial balance equal.

Example 2 – excess debit in one account is compensated by excess credits in two different accounts

Suppose the purchases account is debited with $7,000 instead of $5,000. In the same accounting period, the insurance payable account is credited with $2,500 instead of $2,000, and the sales account is credited with $9,000 instead of $7,500. If we consider these errors individually, the error in the purchases account will cause an excess debit of $2,000, the error in the insurance payable account will cause an excess credit of $500, and the error in the sales account will cause an excess credit of $1,500. Hence, these errors will cause incorrect balances in the purchases account, the insurance payable account, and the sales account. However, if we consider all three errors collectively, their net impact will be zero, because the excess debit of $2,000 in the purchases account will be offset with the excess credit of $500 in the insurance payable account and of $1,500 in the sales account. These errors are therefore compensating errors.

If no other errors, except the ones discussed above, exist in the ledger, and a trial balance is prepared, there will be no discrepancy in it; that is, both debit and credit columns will produce the same total. To correct the accounting records, a bookkeeper or accountant must catch and fix all three compensating errors one by one.