BM2002

CORRECTION OF ERRORS
According to Robles and Empleo (2017), errors, by their nature, occur in unpredictable and more often, illogical
ways. Some errors are automatically discovered through the proper use of the double-entry system, while the
internal and external auditors discover others.
KINDS OF ERRORS
Three (3) Kinds of Errors (Kieso, Weygandt, & Warfield, 2017)
• Statement of financial position errors - These are errors that affect only the presentation of an asset, liability,
or stockholders’ equity account. Examples are the classification of a short-term receivable as part of the
investment section, the classification of a note payable as an account payable, and the classification of
plant assets.
When the error is discovered, the company reclassifies the item to its proper position. If the company
prepares a comparative statement that includes the error year, it should correctly restate the balance sheet
for the error year.
• Income statement of errors – Income statement errors involve the improper classification of revenues or
expenses. Examples include recording interest revenue as part of sales, purchases as bad debt expense,
and depreciation expense as interest expense. An income statement classification error has no effect on
the balance sheet and no effect on net income.
• Statement of financial position and income statement errors - These errors involve both statement of
financial position and income statement account. For example, assume that the bookkeeper accrued wages
payable at the end of the accounting period. The effect of this error is to understate expenses, understate
liabilities, and overstate net income for that period. This type of error can be counterbalancing or non-
counterbalancing.

COUNTERBALANCING ERRORS
These are errors that will be offset or corrected over two (2) periods. For example, the failure to record accrued
wages is a counterbalancing error because, over two (2) years, the error will no longer be present. In other
words, the failure to record accrued wages in the previous period means (1) net income for the first period is
overstated, (2) accrued wages payable (a liability) is understated, and (3) wages expense is understated. In the
next period, net income is understated, accrued wages payable is correctly stated wage expense is overstated.
For the two (2) years combined: (1) net income is correct, (2) wages expense is correct, and (3) accrued wages
payable at the end of the second year is correct. Most errors in accounting that affect both the balance sheet
and income statement are counterbalancing.
Illustrative Example 1. Failure to record accrued wages
On December 31, 2X17, Geng Enterprises did not accrue wages in the amount of P150,000. The entry in 2X18
to correct this error, assuming Geng has not closed the books for 2X18, is:

Retained earnings 150,000

Salaries and wages expense 150,000
The rationale for this entry is as follows: (1) When Geng pays the 2X17 accrued wages in 2X18, it makes an
additional debit of P150,000 to salaries and wages expense. (2) Salaries and wages expense for 2X18 is
overstated by P150,000. (3) Because the company did not record 2X17 accrued wages as salaries and wages
for 2X17, the net income for 2X17 was overstated by P150,000. Because 2X17 net income is overstated by
P150,000, the retained earnings account is also overstated by P150,000. If Geng has closed the books for
2X18, it makes no entry because the error is counterbalanced.

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The following are common counterbalancing errors and their effects on the profits for two (2) periods.

Type of adjustment error Effect on profit for the Effect on profit for
current year next year
Ending inventory overstated Overstated Understated
Ending inventory understated Understated Overstated
Failure to accrue expense at year-end Overstated Understated
Overstated accrued expense at year-end Understated Overstated
Failure to accrue revenue at year-end Understated Overstated
Overstated accrued revenue at year-end Overstated Understated
Overstated year-end prepaid expense Overstated Understated
Understated year-end prepaid expense Understated Overstated
Understatement of year-end liability for revenue Overstated Understated
received in advance
Overstatement of year-end liability for revenue Understated Overstated
received in advance

NON-COUNTERBALANCING
These are errors that are not offset in the next accounting period. An example would be the failure to capitalize
on equipment that has a useful life of five (5) years. If we expense this asset immediately, expenses will be
overstated in the first period but understated in the next four (4) periods. At the end of the second period, the
effect of the error is not fully offset. Net income is correct in the aggregate only at the end of five (5) years
because the asset is fully depreciated at this point.
Illustrative Example 2. Failure to record depreciation
On January 1, 2X21, Chino Enterprises purchased a machine for P100,000 that had an estimated useful life of
five (5) years. The accountant incorrectly expensed this machine in 2X21 but discovered the error in 2X22. If
we assume that Chino uses straight-line depreciation on this asset, the entry on December 31, 2X21, to correct
this error, given that Chino has or has not closed the books, is as follows:
Chino has not closed the books for 2X22:
Equipment 100,000
Depreciation expense 20,000
Retained earnings 80,000*
Accumulated depreciation - equipment 40,000

*Overstatement of expense in 2X21 P100,000

Proper depreciation for 2X21 (20% x P100,000) (20,000)
Retained earnings understated as of December 31, 2X21 P80,000
Chino has closed the books for 2X22:
Equipment 100,000
Retained earnings 60,000*
Accumulated depreciation - equipment 40,000

*Retained earnings understated as of December 31, 2X21 P80,000

Proper depreciation for 2X21 (20% x P100,000) (20,000)
Retained earnings understated as of December 31, 2X21 P60,000
ERROR CORRECTION
According to Robles and Empleo (2017), the approach taken in correcting an error is difficult to generalize
because of the numerous kinds of errors that may occur. Each of these errors should be examined carefully to
determine:
(1) how the transaction was erroneously recorded; and

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(2) how the transaction should have been correctly recorded.

From this analysis, an appropriate correcting entry is made either by:
(1) a single comprehensive correcting entry; or
(2) reversal of original erroneous entry, then recording the correct entry.
The first procedure, however, is the preferred method in practice.
A logical sequence of steps for the analysis and correction of error is as follows (Robles & Empleo, 2017):
• Analyze the original erroneous journal entry and determine all the debits and credits that were recorded.
• Determine the correct journal entry and the appropriate debits and credits.
• Evaluate whether the error has caused additional errors in other accounts.
• Prepare the correcting entry or entries, remembering to record any corrections of the revenues and
expenses for prior periods as adjustments to retained earnings.
Illustrative Example 3. Error correction
Assume that expenditure for machinery was made in the amount of P1,000,000. This amount was recorded as
repair expense when it was found that such an expenditure would benefit the company for the remaining five-
year life of the machinery; hence, it should be capitalized.
An analysis could be as follows:
The wrong entry made:
Repair expense 1,000,000
Cash 1,000,000
The correct entry that should have been made:
Machinery 1,000,000
Cash 1,000,000
Correcting entry:
Machinery 1,000,000
Retained earnings 1,000,000

References
Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2017). Intermediate Accounting (16th Ed.). John Wiley & Sons.
Robles, N. S., & Empleo, P. M. (2017). Intermediate Accounting (Vol. 3). Millennium Books, Inc.

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