When purchase of an asset is treated as an expense, in the accounting context, it is called :

Correct — A, (a) Error of principle. Treating the purchase of an asset as an expense means debiting a revenue account where a capital account should have been debited, and an error of that kind — a breach of an accounting principle rather than a slip of the pen — is called an error of principle.

The entry actually made is, say, Repairs A/c Dr. To Cash. The entry that should have been made is Machinery A/c Dr. To Cash. Both are complete double entries: a debit of the right amount matched by a credit of the right amount. Only the CLASSIFICATION of the debit is wrong. Two consequences follow, and both are examinable.

First, the trial balance will still agree. A trial balance tests only the arithmetical equality of debits and credits. Because the wrong entry is arithmetically sound, nothing in the trial balance reveals it, and the error can survive into the final accounts undetected. Errors of principle sit with errors of complete omission, compensating errors, and errors of original entry among the errors a trial balance cannot catch.

Second, the financial statements are materially wrong in a specific direction. Charging a capital item to revenue understates the profit of the year by the full amount and understates the assets in the balance sheet; in every later year it overstates profit, because the depreciation that should have been charged on the asset is not. The reverse error — treating revenue expenditure as capital — overstates the current year's profit and the assets. Both are errors of principle, and both distort profit and the balance sheet together.

That is why the answer here is not one of the three mechanical categories offered beside it. Omission, commission and compensating errors describe HOW an entry went wrong in the recording process; an error of principle describes an entry recorded correctly as a mechanical matter but against the wrong kind of account.

Why the others are wrong

• (b)Error of omission — An error of omission is a failure to record a transaction, in whole or in part. If it is a COMPLETE omission — the transaction never enters the books at all, a purchase invoice mislaid before it reached the day book — the trial balance still agrees, because neither the debit nor the credit was made. If it is a PARTIAL omission — the entry is made in the journal or subsidiary book but posted to only one of the two ledger accounts — the trial balance disagrees by the amount omitted. Neither describes this question. Here the transaction was recorded, and recorded on both sides; what went wrong was the choice of account, not the fact of recording.
• (c)Error of commission — An error of commission is a mechanical mistake made while recording a transaction that is otherwise correctly conceived: posting to the wrong personal account, entering a wrong amount, a wrong casting or carry-forward, a wrong balancing. Its distinguishing feature is that the account used is of the RIGHT CLASS but the wrong one within it — a credit purchase from Mr. Singh credited to Mr. Akash, both of them creditors. It is easy to confuse with an error of principle because both involve a debit or credit going to the wrong account, but the line is clear: commission means the wrong account within the right category, principle means the wrong category altogether. Debiting an expense account instead of an asset account crosses categories, so it is an error of principle.
• (d)Compensating error — A compensating error is a combination of two or more errors whose effects cancel out in the trial balance — an account overcast on the debit side by ₹ 500 and another overcast on the credit side by ₹ 500, so the totals still agree while both accounts are wrong. It is defined by the cancelling, and it needs at least two errors. This question describes a single wrong entry, not a pair. The two categories do share the property of leaving the trial balance in agreement, which is why compensating errors and errors of principle are always listed together among the errors a trial balance cannot detect, but they are different things: a compensating error is arithmetically self-cancelling, an error of principle is arithmetically correct from the start.

Accounting errors are classified by what went wrong, and the classification also predicts whether the trial balance will reveal the error. ERROR OF OMISSION: a transaction is not recorded, wholly — in which case the trial balance still agrees — or partly, where one side is posted and the other is not, in which case it does not. ERROR OF COMMISSION: a mechanical mistake in recording or posting a correctly understood transaction, such as posting to the wrong person's account, a wrong amount, a wrong casting or a wrong carry-forward; whether the trial balance agrees depends on whether the mistake was made on one side or both. ERROR OF PRINCIPLE: a transaction is recorded against the wrong class of account — capital treated as revenue or the reverse — with correct double entry, so the trial balance always agrees. COMPENSATING ERRORS: two or more errors whose effects on the two sides cancel, so the trial balance agrees. The examinable summary is therefore that a trial balance detects only those errors that disturb the equality of debits and credits, and is blind to complete omissions, errors of principle, compensating errors, and errors of original entry where the wrong amount was entered on both sides. Where the trial balance does disagree and the difference cannot be traced before the accounts are prepared, the difference is carried to a SUSPENSE ACCOUNT, a temporary account closed as the errors are located and rectified. Rectification itself follows from the classification: an error found before the trial balance is corrected by a journal entry between the accounts concerned; one found after the suspense account has been opened is corrected through that account.

Key facts

• An error of principle is a transaction recorded against the wrong CLASS of account — capital treated as revenue or revenue as capital — with double entry otherwise correct.
• An error of principle never affects the agreement of the trial balance, because both the debit and the credit are of the right amount.
• Treating a capital expenditure as revenue understates the current year's profit and the assets, and overstates profit in later years by omitting depreciation.
• Treating a revenue expenditure as capital overstates the current year's profit and the assets.
• An error of omission is the failure to record a transaction; complete omission leaves the trial balance in agreement, partial omission does not.
• An error of commission is a mechanical mistake — wrong account within the right class, wrong amount, wrong casting, wrong carry-forward or wrong balancing.
• A compensating error is two or more errors whose effects cancel out in the trial balance.
• The trial balance cannot detect complete omissions, errors of principle, compensating errors, or errors of original entry made identically on both sides.
• A difference in the trial balance that cannot be traced is carried to a suspense account, which is temporary and is closed as the errors are rectified.

Common traps

• Choosing error of commission because an account was wrongly debited. Commission means the wrong account within the right class; crossing from revenue to capital is principle.
• Assuming any undetected error is a compensating error. Compensation requires at least two errors that cancel.
• Believing an agreed trial balance proves the books are correct. It proves only arithmetical equality.
• Forgetting the direction of the distortion — charging a capital item to revenue understates this year's profit and overstates later years'.

• practice — not a real PYQ

  Which one of the following errors will NOT cause the trial balance to disagree ?

  • (a)A purchase of ₹ 4,000 posted to the debit side of the purchases account as ₹ 400
  • (b)A sale omitted from the sales day book altogether
  • (c)The sales account undercast by ₹ 1,000
  • (d)A payment to a creditor posted only to the cash account

  Answer(b) A sale omitted from the sales day book altogether

• practice — not a real PYQ

  Wages paid for the installation of a new machine have been debited to the wages account. This is :

  • (a)An error of omission
  • (b)An error of commission
  • (c)An error of principle
  • (d)A compensating error

  Answer(c) An error of principle