What it means
Most people think of accounting errors as typing mistakes or missed entries. An error of principle is different because the entry is complete and the totals agree, but the wrong category is used.
The amounts are correct, yet the treatment goes against accounting principles. The classic case is confusing capital expenditure with revenue expenditure.
If a business pays $20,000 for repairs and records it as a new piece of equipment, profit for the year is overstated and assets are overstated. The books balance, so the error can sit unnoticed for a long time.
These errors matter because they distort the financial statements that managers, lenders and tax authorities rely on. Overstated profit can lead to higher tax, excess dividends or a misleading picture of performance.
Understated profit can hide a healthy business. Finding them requires review rather than arithmetic.
Accountants look at unusual items, compare spending to expectations and ask whether each entry fits the nature of the transaction. Strong policies on what counts as an asset, written clearly and applied consistently, are the best prevention.
Once found, the error is corrected by a journal entry that moves the amount to the right account. If the amount is large enough to mislead users of the accounts, previous financial statements may need restating.
Good record keeping makes this process quicker and less painful.
In practice
Real-world examples.
Example
A building firm pays $8,000 to fix a leaking roof and records the payment as an improvement to the building. Its profit is overstated, and the building appears more valuable than it should. The auditors find the issue during year-end testing. The cost is moved to repairs expense, and last year's profit is restated.
Example
A cafe owner buys a $2,500 coffee machine and records the cost as a normal expense. Profit for the year is understated, and the machine does not appear as an asset. The accountant corrects the books and sets up depreciation. The cafe's tax bill rises slightly once the correct profit is shown.
Example
A consultancy records an owner's personal holiday of $6,000 as a business travel cost. The books balance, but the entry is wrong in principle, as the cost is a drawing and not an expense. The tax adviser reverses the entry before the tax return is filed. The owner is reminded to keep personal and business spending separate.
Formula
Calculation
Corrected profit = Reported profit - Amount wrongly capitalised + Depreciation wrongly charged on that amount
Worked example: A company reports profit of $150,000. It wrongly records $20,000 of repairs as equipment and charges no depreciation on it in the first year.
Corrected profit = $150,000 - $20,000 = $130,000
The reported profit was overstated by $20,000, or about 15% of the true figure. The correcting entry debits repairs expense by $20,000 and credits the equipment account by $20,000.Case study
Seen in the real world.
Larkspur Printing is an illustrative, fictional company that was preparing accounts for a bank loan application. A new bookkeeper noticed that $45,000 of routine machine servicing had been recorded as machinery over two years.
Because the entries balanced, nobody had questioned them. The accountant reviewed the invoices, agreed that the work was maintenance and corrected the books by moving the amount to repairs expense. The review took two days but gave the owners much greater confidence in the accounts.
In this illustrative story, profit for the earlier year was lowered by the corrected amount, and the owners had to explain the change to the bank. The lender accepted the explanation because the company had found and fixed the error itself. Larkspur added a written capitalisation policy with a clear dollar threshold to prevent a repeat.
Watch out
Common mistakes.
- Assuming a balanced trial balance means the books are correct, when errors of principle do not upset the totals.
- Ignoring small repeated items, when many small wrongly classified entries can add up to a material misstatement.
- Fixing the error only in the current year, when earlier periods may also need to be corrected if they were affected.
Questions
People also ask.
What is the difference between an error of principle and an error of commission?
An error of principle breaks an accounting rule by using the wrong type of account, while an error of commission puts the right type of entry in the wrong account of the same kind.
How does a business detect these errors?
Reviews of unusual items, comparisons with budgets and examination of supporting invoices usually reveal them. Regular reviews by someone independent of the person who made the entries work especially well.
Do these errors affect tax?
Yes, because wrongly classifying costs changes taxable profit, and corrections may mean amended tax filings. Tax authorities can charge interest or penalties if an error leads to an underpayment.
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