Overview of Statement Changes and Errors
Despite best efforts, occasionally an error is made on the financial statement and must be corrected.
Explain why a previously issued financial statement would have an error and how to correct it
- These errors are most usually caused by mathematical mistakes, mistakes in applying generally accepted accounting principles, or through the oversight of facts existing when the financial statements were prepared.
- In order to properly correct an error, it is necessary to retrospectively restate the prior period financial statements.
- A counterbalancing error occurs when an an error is made that cancels out another error.
- It makes no difference whether the books are closed or still open; a correcting journal entry is necessary.
- offset: Anything that acts as counterbalance; a compensating equivalent.
- cumulative: Incorporating all data up to the present
- retrospectively: In a retrospective manner.
Changes and Errors on the Financial Statements
Despite best efforts, occasionally an error is made on the financial statement. Most often, the error is in the recognition, measurement, presentation, or disclosure of an item in financial statements. These errors are usually caused by mathematical mistakes, mistakes in applying generally accepted accounting principles, or the oversight of facts existing when the financial statements were prepared.
Please note: an error correction is the correction of an error in previously issued financial statement; it is not an accounting change.
How to Correct an Error
In order to properly correct an error, it is necessary to retrospectively restate the prior period financial statements. In order to restate the financials the company must:
- Reflect the cumulative effect of the error on periods prior to those presented in the carrying amounts of assets and liabilities as of the beginning of the first period presented; and
- Make an offsetting adjustment to the opening balance of retained earnings for that period; and
- Adjust the financial statements for each prior period presented, to reflect the error correction.
If the financial statements are only presented for a single period, then reflect the adjustment in the opening balance of retained earnings.
Counterbalancing vs. Non-counterbalancing Errors
A counterbalancing error has occurred when an error is made that cancels out another error. An example of a counterbalancing error is expenses charged to year X that should have been charged to year Y. The result is year X has an overstated expense and an understated profit and year Y has an expense understated and the profit overstated. Yet when retained earning for year Z is correct, because the two previous errors cancelled each other out. While the effects of the error are corrected over a period of two years, the yearly net income figures for year X and year Y were still misstated.
Accounting for a counterbalancing error is made by determining if the books for the current year are closed or not. If the current year books are closed-no entry is necessary if the error has already counterbalanced. If the error has not counterbalanced then an entry must be made to retained earnings.
If the books are not closed for the current year, the company is in the second year, and the error hasn’t already counterbalanced then it is necessary to correct the current period and adjusted beginning retained earnings. If the error has not counterbalanced, an entry is necessary to adjusted beginning retained earnings and correct the current period.
Keep in mind the financial statements need to be re-run no matter what.
Non-counterbalancing errors are those that will not be automatically offset in the next accounting period. It makes no difference whether the books are closed or still open, a correcting journal entry is necessary.