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Prior Period Errors

Prior period errors are omissions from, and misstatements in, an entity's financial statements for one or more
prior periods arising from a failure to use, or misuse of, reliable information that was available and could
reasonably be expected to have been obtained and taken into account in preparing those statements.

Examples of accounting errors included the following:

Misapplication of accounting policies: e.g. not recognizing sale upon transfer of goods to a customer
Fraud: e.g. overstating sales revenue by issuing fake invoices before the reporting date
Misunderstanding of, or failure to notice, information at the time of preparation of financial
statements: e.g. not writing off a receivable who had been announced as insolvent before the
authorization of financial statements
Arithmetical Errors
Omission of transactions and events from the financial statements

An entity must correct all material prior period errors retrospectively in the first set of financial statements
authorised for issue after their discovery by:

restating the comparative amounts for the prior period(s) presented in which the error occurred; or
If the error occurred before the earliest prior period presented, restating the opening balances of
assets, liabilities and equity for the earliest prior period presented.

However, if it is impracticable to determine the period-specific effects of an error on comparative information


for one or more prior periods presented, the entity must restate the opening balances of assets, liabilities, and
equity for the earliest period for which retrospective restatement is practicable (which may be the current
period).

Further, if it is impracticable to determine the cumulative effect, at the beginning of the current period, of an
error on all prior periods, the entity must restate the comparative information to correct the error
prospectively from the earliest date practicable.

Types of Errors

1.) Statement of financial position errors


2.) Income statement errors
3.) Combined statement of financial position and income statement errors

Statement of Financial Position Errors

These errors affect the statement of financial position or real accounts, meaning, the improper classification
of an asset, liability, or capital account.

Illustrations:

a.) Notes receivable is debited instead of accounts receivable


Accounts Receivable XX
Notes Receivable XX

b.) Accounts payable is credited instead of notes payable


Accounts Payable XX
Notes Payable XX
Income Statement Errors

These errors affect the income statement or nominal accounts only, meaning, the improper classification of
revenue and expense accounts. They have no effect in the statement of financial position and on net income.
A reclassifying entry is only necessary if the error is discovered in the same year it is committed. If the error is
discovered in a subsequent year, no reclassifying entry is necessary because the nominal accounts for the
current year are correctly stated.

Illustration:

a.) The entity debited purchases instead of office supplies in 2015.

Error discovered in 2015:


Office Supplies XX
Purchases XX

Error discovered in 2016:


No entry

Combined Statement of Financial Position and Income Statement Errors


These errors affect both the statement of financial position and income statement because they result in a
misstatement of net income.

Examples:
Overlooked accrued salaries payable
Over- and under-statement of depreciation expense
Misstatement of inventory

Classifications of Combined Statement of Financial Position and Income Statement Errors

1.) Counterbalancing Errors if not detected, are automatically counterbalanced or corrected in the next
accounting period. These errors will be offset or correct themselves over 2 periods.
2.) Noncounterbalancing Errors if not detected, are not automatically counterbalanced or corrected in
the next accounting period. If the net income of one year is understated or overstated, the net income
of the subsequent year is not affected.

Counterbalancing errors normally include the following:

Inventory, including purchases and sales


Prepaid Expense
Accrued Expense
Deferred Income
Accrued Income

Noncounterbalancing errors include:

Mistatement of depreciation
Illustration 1

Hugaw kog tiil Company reported net income for 2013 P3,000,000, 2014 P4,000,000, and 2015 P3,500,000.

1.) December 31, 2013 inventory overstated 120,000


2.) December 31, 2015 invenotory understated 210,000
3.) December 31, 2013 accrued interest payable understated 40,000
4.) December 31, 2015 accrued interest payable overstated 90,000
5.) Depreciation for 2014 understated 180,000
6.) Depreciation for 2015 overstated 30,000

Required: Corrected net income for 2013, 2014, and 2015.

Answer:

2013 2014 2015


Net income per book P 3,000,000 P 4,000,000 P 3,500,000
1.) Overstatement of 2013 inventory (120,000) 120,000
2.) Understatement of 2015 inventory 210,000
3.) Understatement of 2013 accrued interest payable (40,000) 40,000
4.) Overstatement of 2015 accrued interest payable 90,000
5.) Understatement of 2014 depreciation (180,000)
6.) Overstatement of 2015 depreciation 30,000
Corrected Net Income P 2,840,000 P 3,980,000 P 3,830,000

Correcting Entries on December 31, 2015 (2015 books have not yet been closed)

1.) No adjustment. Counterbalanced already.

2.) Inventory December 31, 2015 210,000

Profit or Loss 210,000

3.) No adjustment. Counterbalanced already.

4.) Accrued Interest Payable 90,000

Interest Expense 90,000

5.) Retained Earnings 180,000

Accumulated Depreciation 180,000

6.) Accumulated Depreciation 30,000

Depreciation 30,000
Illustration 2

Pangit ko Company is a calendar-year entity. The financial statements contained the following errors:

December 31, 2014 inventory overstated 35,000

December 31, 2015 inventory understated 10,000

Depreciation for 2014 overstated 25,000

Depreciation for 2015 understated 8,000

December 31, 2014 prepaid insurance understated 5,000

December 31, 2015 unearned rent overstated 4,000

December 31, 2015 accrued salaries understated 20,000

Required:

What is the effect of the errors on the following?

a.) Net Income for 2015


b.) Retained Earnings on December 31, 2015
c.) Working Capital on December 31, 2015

Answer:

December 31, 2015


Retained Working
Net Income Earnings Capital
December 31, 2014 inventory overstated 35,000
December 31, 2015 inventory understated 10,000 10,000 10,000
Depreciation for 2014 overstated 25,000
Depreciation for 2015 understated (8,000) (8,000)
December 31, 2014 prepaid insurance
understated (5,000)
December 31, 2015 unearned rent overstated 4,000 4,000 4,000
December 31, 2015 accrued salaries understated (20,000) (20,000) (20,000)
16,000 11,000 (6,000)
Net Effect understated understated overstated