Correction of Error LECTURE

 

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2nd Flr, GF Partners Bldg, 139 H.V. dela Costa, Salcedo Village, Makati City

 AUDITING PROBLEMS PROBLEMS  Accounting for Changes and Correction of Errors

Prof . L.O. Aristorenas

 

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Definition of Ters  Accounting !o"icies # specific speci fic principles, principles, bases, conventions, conventions, rules and practices adopted by an enterprise in preparing and presenting the financial statements. $undaenta" errors # are errors discov discovere ered d in the current period period with with such significance, that the financial statements of one or more prior periods can no longer be considered to have been reliable at the date of their issue. 

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Reasons %h& Accounting Changes Occur: Occur : 1. he ac acco coun untin ting g prof profes essi sion on may may mand mandat ate e that that a new new accou account ntin ing g prin princip ciple le is is to be be used used.. !. "hanging economic conditions #. "hanges iin n te technolo ology an and iin n op operat ration onss $.

%e %ew w e&per e&perie ienc nce e or new info inform rmat atio ion n may prom prompt pt comp compan anie iess to chang change e its its estim estimat ate e of  revenues or e&penses.

T'PES O$ ACCOUNTING C(ANGES )* Change in Accounting Princi!"e !"es his is a change from one generally accepted accepted accounting accounting principle to another generally accepted accep ted accounting accounting principle. principle. Adoption Adoption of a new principle principle in recognition recognition of events that have occurre occ urred d for the 1st time is not a change change in accounti accounting ng principle principle.. here here is no change change in accoun acc ounting ting princi principle ple whe when n the deprec deprecia iation tion method method adopt adopted ed for a newl newly y ac'uire ac'uired d asset asset is different from the method or methods used for previously recorded assets of similar class.  A change from a principle that is not generally accepted to one that is generally accepted is considered to be an error correction than a change in accounting principle.  Accounting Procedure+  Accounting Benchar, treatent  A change in accounting policy(principle should be applied retroactively unless the amount of any resulting ad)ustment that relates to prior periods is not reasonably determinable.  Any resulting ad)ustment should be reported as an ad)ustment to the opening balance of the retained earnings. "omparative information should be restate restated d unless it is impracticable to do so. -*

Change in Accounting Accounting Estiate his is a change that occur as a result of new information or ac'uisition of additional e&perience. "hanges in estimates are viewed as normal recurring corrections and ad)ustments or the natural result of the accounting process. *etroactive treatment is prohibited.

 Accounting Procedure+  Accounting a. *eport current and future financial statements on the new basis. b. Present prior period financial statements as previously reported. c. +ae +ae no ad) ad)us ustm tment ent to cu curre rrent nt per perio iod d ope openi ning ng bal balan ances ces..

 

2 NOTE+ -henever it is impossible to determine whether a change in principle or a change in estimate estima te has occurred, or if an asset is affected by both a change in principle and a change in estimate during the same period, the change should be accounted for as a change in estimate rather than a change in principle.

CORRECTION O$ ERRORS %o company whether whether large or small small is immune from errors. rrors may be intentiona intentionall or unintentional. /ntentional errors are significant because of the presence of fraud or intent to deceiv dec eive. e. hese hese errors errors are made for the pur purpos pose e of concealin concealing g fraud fraud or misappropr misappropriat iation ion,, ev evad adin ing g ta&e ta&es, s, ma mani nipu pula latin ting g or wind window ow0d 0dre ressi ssing ng the the compa company nys s fi fina nanci ncial al st stat atem emen ents. ts. 2ninte 2ni ntentio ntional nal errors were not del delibe iberat rately ely commi committe tted. d. hey hey result result from carelessn carelessness ess or ignorance on the part of the companys personnel or it may result from poor internal control. he ris of material errors may be minimi3ed through the installation of good internal control and the applicati application on of sound accounting accounting procedures. procedures. Prior period period ad)ustments, ad)ustments, also called fundamental errors are reported in the current year as ad)ustment in the beginning balanc bal ance e of the *etain *etained ed arnings arnings accoun account. t. Prior Prior per period iod stateme statements nts should be restate restated d to correct the error when comparative statements are prepared.  Accounting Procedure+ 1. /f det detec ecte ted d iin n the the per perio iod d the the e erro rrorr occur occurre red, d, cor correc rectt tthe he acc accoun ounts ts thr throug ough h norma normall accounting cycle ad)ustments. !. /f detected in subse'uent period, ad)ust errors by maing prior period ad)ustments directly to *etained arnings or restate the beginning balance of the *etained arnings account. #.

"o "orr rrec ectt all all prev previo ious usly ly pre prese sent nted ed prio priorr peri period od st stat atem emen ents ts..

&les of Accounting errors: a. A chan change ge from from an an acco accoun untin ting g prin princi cipl ple e that that is is no nott gene genera rall lly y ac acce cept pted ed to an an accou accounti nting ng principle that is generally accepted. b. +athematical mistaes c. +i +ist sta ae e in the the app appli lica cati tion on of of a acc ccou ount ntin ing g of acc accou ount ntin ing g prin princi cipl ple e d. Oversight e. +isuse of facts f. /n /nco corr rrec ectt ccla lass ssif ific icat atio ion no off e e&p &pen ense se as an as asse sett or or v vic ice e ver versa sa g. "han "hange gess in in est estim imat ates es whic which h are are no nott pre prepa pare red d in in goo good d fai faith th

T'PES O$ ERRORS )* Ba"ance Sheet Errors   his ttype ype of error refers to improper improper classifica classification tion of of real real accounts accounts such such as assets, assets, liabilities or stocholders e'uity accounts. accounts. hey have no effect effect on net income -* Incoe Stateent Errors   his ttype ype of error affects affects only only the presentatio presentation n of nominal nominal accounts accounts in the the /ncome 4tatement. 4tate ment. /t involves involves the improper classification classification of revenues and e&penses accoun accounts, ts, hence, only the details of the /ncome 4tatement are misstated. A reclassifying entry is necessary only if the error is discovered discovered in the sam same e year it is committed. committed. /t has no effect on the 5alan 5alance ce sheet she et and in the /ncome /ncome 4tateme 4tatement. nt. /f the error is discov discovere ered d in a subse'ue subse'uent nt year, year, no classification entry is necessary. .* Co/ Co/in ined ed Ba"a Ba"anc nce e She Sheet et and and In Inco coe e St Stat ate een entt err error ors s   his affects both the balance 4heet and the /ncome 4tatement because they result in the misstatement of net income. C"assifications of Co/ined Ba"ance Sheet and Incoe Stateent Errors+ a* Counter Ba"ancing Errors rrors rro rs whi which ch if not det detect ected ed are automati automaticall cally y offset offset or correct corrected ed over over two periods. Restateent is necessar& e0en if a correcting 1ourna" entr& is  not re2uired* 

 

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Effect+ %et /ncome of two two successive successive periods are misstate misstated. d. he amount of  misstatement in one period is e'ual to but opposite in effect in the income of the ne&t period. "ounterbalancing errors include the misstatements of the following accounts: 1. /nventories to include the following   a. Purchases   b. 4ales !. Prepaid e&penses #. 6eferred /ncome $. Accrued e&pense 7. Accrued /ncome

GUIDELINES 5oos are open 1. /f the error error is alread already y co coun unte terba rbala lance nced d and and the the co comp mpan any y is in the the second year, an entry is necessary necessary to correct the current period and to ad)ust the beginning balance of the *etained earnings. !. /f the error error is not yet counte counterba rbalan lanced ced,, an entry is necessar necessary y to ad)us ad)ustt the beginning balance of the *etained earnings and correct the current period. 5oos are closed 1. /f the error is already already counterba counterbalance lanced, d, no entry is necessary. necessary. !. /f the error error is not yet counter counterbal balanc anced, ed, an entry entry is necessa necessary ry to ad)ust ad)ust the present balance of the *etained earnings. 

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Non Counter Ba"ancing Errors  rrors which tae longer longer than two peri periods ods to correct themselves themselves.. his type of  error is carried carried over to the subse'uent subse'uent accounting period until corrected corrected or until the bala balanc nce e shee sheett it item em invo involv lved ed is remov removed ed from from the the ac acco coun unts ts by sale sales, s, retirement or other means of disposal. 

GUIDELINES IN ERROR ANAL'SIS 1. -hat accounts ar are affected8 !. 9ow we were th these ac accounts af affected8 -as tth here an an un understatement or or an an overstatement8 #. -h -hat at was was the the erro errone neou ouss entr entry y mad made e or or what what was was the the en entr try y omi omitt tted ed88 $. -hat is tth he correct entry8 7. -h -hat at is the the ne nece cess ssar ary ya ad) d)us usti ting ng or corr correc ecti ting ng en entr try8 y8 END