Explanation of why the correct answer is a) Error of principle:

Recording “Goods sent on approval basis” as “Credit sales” represents an error of principle. This type of error occurs when a transaction is recorded in a fundamentally incorrect account due to a misunderstanding or misapplication of accounting principles. In this case, the error stems from a failure to differentiate between two distinct types of transactions.

“Goods sent on approval basis” refers to a situation where a business sends goods to a customer for examination or trial before finalizing the sale. This is not a sale at the time of sending, but rather a consignment of goods for potential future sale.

On the other hand, “Credit sales” indicate actual sales where goods or services have been sold on credit to a customer. This means that the revenue is recognized at the time of sale, regardless of when the payment is received.

By incorrectly recording goods sent on approval as credit sales, the company is recognizing revenue prematurely. This misrepresentation can lead to distorted financial statements, potentially inflating revenue and profit figures.

It violates the revenue recognition principle, a fundamental accounting principle that dictates revenue should be recognized when it is earned and realized or realizable.

Explanation of why the other options are not correct:

b) Error of commission:

An error of commission involves making a mistake during the process of recording a transaction. This could be due to mathematical errors, posting to the wrong account, or transposition errors. For example, if a company accidentally records a sale for $1,000 as $10,000, that would be an error of commission.

In the given scenario, however, the issue isn’t a mistake in the recording process itself. Instead, it’s a fundamental misunderstanding of the accounting principle regarding when to recognize revenue.

The goods sent on approval basis were incorrectly treated as credit sales, which indicates a misinterpretation of the revenue recognition principle.

c) Error of omission:

An error of omission occurs when a transaction is entirely left out of the accounting records. For instance, if a company forgets to record a sale, that would be an error of omission.

In this scenario, the transaction has been recorded; however, it has been classified incorrectly. It’s not a case of omitting the transaction, but rather a misclassification error.

The goods sent on approval were recorded, but they were categorized as credit sales instead of the correct category, which would be a consignment or goods sent on approval.

d) Error of duplication:

An error of duplication involves recording a transaction twice, leading to an overstatement of both assets and liabilities. For example, if a company accidentally records the same sale twice, it would result in an overstatement of both cash (or accounts receivable) and revenue.

In this scenario, there is no indication of a duplicated entry. The issue at hand is related to misclassification rather than duplication. The goods sent on approval basis were recorded once, but they were wrongly categorized as credit sales instead of being appropriately accounted for as goods sent on approval.

In summary, options b, c, and d do not accurately describe the nature of the error in this scenario. The fundamental mistake lies in the application of accounting principles, particularly the revenue recognition principle.

The goods sent on approval basis were incorrectly recognized as credit sales, indicating a misunderstanding of when revenue should be recorded. Therefore, option (a) – error of principle – is the most fitting description of the error in this context.