Expert: Don Sadler - 3/9/2008

Question
Hi Don - I'll understand if you tell me to take a hike, as this is not the expertise area in which I should be; however, if you can help, I'd appreciate it.
I did a double entry on $5k of revenue in my 2006 books. I'm guessing that to take care of this in this fy, I can DR "Retained Earnings - Previous Year" and CR "Bank Account" which is $5K too high. (Don't ask me why I didn't notice this last year... my accounting education consists of a 12-week university extension class... with which I'm acting as bookkeeper for our small home-based business).
Best regards,
Marcy

Answer
I am not an accounting expert so, with that caveat, I will pass on what my CPA friend told me.


"Apparently he not only doubled the entry to revenue, but also to cash (the AR is not overstated.)  His solution will work to correct the FY07 books, and if FY06 is closed, that's the best option.  If FY06 is open, he can debit revenue and cedit cash in "06, and the year-end closing process will close out the revenue account to the retained earnings. He probably overpaid and has a refund coming when he files an amended return."

---I requested a better explanation---

"Back in 2006, when he booked a duplicate revenue entry, all entries have both a credit and debit, and affect two accounts.  A sales transaction is either revenue (CR) & accounts receivable (DR), with subsequent collection to CR A/R (remove the receivable) and DR cash (increase the cash balance), OR, in his case, since the bank account is overstated, he must not have done it to A/R, so he must have immediately collected cash, and double-booked to both revenue and cash.  Usually, it is to revenue and A/R.

So, at the end of the year he showed 5K too much revenue and 5K too much cash.

Now, in year-end close, all revenue and expense accounts are closed and netted to retained earnings.  That is, you have xxx in revenue, yyy in costs and zz in profit before close, and 0 revenue, 0 cost, and zz (last year's profit) rolled into retained earnings after close, ready to start another year of accumulation of earnings.

When he closed, he had 5k too much revenue, and 5K too much cash, and 5K too much profit, and after close, he still had 5K too much in cash (a debit balance account) and 5K too much in retained earnings (a credit balance account).  So for the subsequent year, he can correct start balances by credit of 5K to cash, debit of 5K to retained earnings.  If he hit revenue this year instead of retained earnings, his revenue this year would be reduced by that amount, erroneously.

Although it would seem simpler to understate the income this year to offset the prior overstatement, if audited, it would not be allowed, and by then it would be too late to go back and refile for the prior year to recapture that.  Also, that 5K error is probably worth a $1500 refund for the prior year re-filed."

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I hope this helpful to you. Again, I am not an accounting expert but thought might point you in the right direction.