ERRORS

- can arise in respect of the recognition, measurement, presentation or disclosure of elements of

financial statements. Accounting errors occur when transactions are recorded incorrectly or
when they are omitted.
Errors include the effects of:
1. Mathematical mistakes
2. Mistakes in applying accounting policies
3. Oversights or misinterpretations of facts; and
4. Fraud
Financial statements do not comply with PFRSs if they contain either material errors or immaterial
errors made intentionally to achieve a particular presentation of an entity's financial position,
financial performance or cash flows.
Material errors are those errors that cause the financial statements to be misstated. Errors made
intentionally refer to fraud.

CURRENT PERIOD ERRORS

Current period errors are errors committed during the current period. Current period errors may be
discovered during the current period or after the reporting period but before the financial statements
are authorized for issue.
Current period errors discovered in that period should be corrected upon discovery. If current period
errors are discovered after the reporting date but before the financial statements are authorized for
issue, such errors should be corrected before the financial statements are authorized for issue as
adjusting events after the reporting period.
➢ "Books still open"
- means that closing entries have not yet been made. Accordingly, nominal accounts can still be
used in correcting entries.

➢ "Books closed”
- means that closing entries have already been made. Consequently, nominal accounts cannot
be used anymore. Instead, correcting entries are made by use of real accounts only.

PRIOR PERIOD ERRORS

Material errors are sometimes not discovered until a subsequent Period, these are prior period errors
which should be corrected in the Comparative information presented in the financial statements for
that subsequent period.
Prior period errors are omissions from, and misstatements in, the entity's financial statements for
one or more prior periods arising a failure to use, or misuse of, reliable information that:
a) was available when financial statements for those periods authorized for issue; and
b) could reasonably be expected to have been obtained and taken into account in the preparation
and presentation of those financial statements
Corrections of errors are distinguished from changes in accounting estimates. Accounting estimates
by their nature are approximations that may need revision as additional information becomes known.
For example, the gain or loss recognized on the outcome of a contingency is not a correction of an
error.

CORRECTION OF PRIOR PERIOD ERRORS

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

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

In other words, prior period errors are corrected by retrospective restatement

Retrospective restatement is correcting the recognition, measurement and disclosure of amounts of

elements of financial statements as if a prior period error had never occurred.

❖ Retrospective restatement pertains to correction of a prior period error as if the prior period
error had never occurred while retrospective application pertains to applying a new
 accounting policy to transactions, other events and conditions as if that policy had always been
applied.

Impracticability of retrospective restatement

Retrospective restatement should be made as far back as practicable. If it js impracticable to
determine the cumulative effect of a prior period error at the beginning of the current period, an entity
is allowed to correct the error prospectively from •the earliest date practicable.

Types of Errors in Accounting

It is nearly impossible to make a complete list of the errors made in accounting

Broad classification of accounting errors into the following:

1) Errors in principle — these may arise, for example, from lack of knowledge of accounting
standards or procedures, misuse of available information, or misinterpretation of accounting
standards, whether intentional or unintentional. Intentional errors are called "fraud. "
Intentional misstatement of financial statements is sometimes referred to as "fraudulent
financial repotting.

2) Clerical errors — these arise from a variety of sources which may include some of those
enumerated under PAS 8 (see previous discussion) and the following: (the list is not exhaustive)
a) Transposition error — for example, an amount of P45,455 is recorded as P45,545. for
example, an amount of
b) Transplacement error P1,000,000 is recorded as P 100,000.
c) Errors of Omission — For example, the accountant forgot to record a transaction.
d) Errors of Commission— For example, the accountant recorded a transaction twice or
partially.
e) Compensating errors — For example, a P500 overstatement in the sales account is
compensated by a P500 overstatement in utilities expense account the erroneous credit is
compensated by the erroneous debit. This error will not be revealed by the trial balance.
f) Accounting system error — For example, there is a “bug” in the computer program.
g) Counterbalancing and Non-counterbalancing errors — See discussion below.

Errors may affect the statement of financial position only, the income only or both. Errors affecting
the statement of financial position only (errors in real accounts) and errors affecting the income
statement only (errors in nominal accounts) are corrected through reclassification from the wrong
account(s) to the appropriate account(s). For example, if advertising expense is incorrectly recorded
as travel expense, the correcting entry would be a debit to advertising expense and a credit to travel
expense.

TYPES OF ERRORS
1. Balance sheet or statement of financial position errors
2. Income statement errors
3. Combined statement of financial position and income statement errors:
a) Counterbalancing errors
b) Non-counterbalancing errors

STATEMENT OF FINANCIAL POSITION OR BALANCE SHEET ERRORS

Statements of Financial Position or balance sheet errors affect only the presentation of an asset,
liability, or stockholders' equity account. When the error is discovered in the error year, the company
reclassifies the item to its proper position. If the error in a prior year is discovered in a subsequent
period, the company should restate the statement of financial position of the prior year for
comparative purposes.

INCOME STATEMENT ERRORS

Income statement errors are errors affecting only the income statement accounts and may include
improper classification of revenues or expenses. A company must make a reclassification entry when
it discovers the error in the error year. If the error discovered pertains to a prior year, the company
should restate the income statement of the prior year for comparative purposes. Since these errors
involve two nominal accounts, net income and retained earnings during the period are unaffected.
COMBINED Statement of Financial Position and Income Statement Errors
Errors affecting both the statement of financial position and income statement can be classified as:
1. Counterbalancing errors and
2. Non-counterbalancing errors

COUNTERBALANCING ERRORS
Counterbalancing errors are errors that will offset or be corrected over two accounting periods.
Examples include the following: Overstatement or Understatement of the following:
1. Error affecting ending inventory.
2. Failure to record Accruals
3. Failure to record Deferrals of Income and Expenses

➢ Sales not recorded in the first year and subsequently recorded the following year (or vice versa).
➢ Purchases not recorded in the first year and subsequently recorded the following year (or vice
versa).

NON-COUNTERBALANCING ERRORS
Non-counter balancing errors do not offset in the next accounting period. Therefore, companies must
make correcting entries, even if they have closed the books.
Examples:
1. Prepayments under the asset method
2. Pre-collection under the liability method
3. Error in recording depreciation
4. Improper capitalization of expense
5. Improper expensing of capital expenditures
6. Error in recording of proceeds of sale of an asset (e.g. PPE) as other income
Non-counter-balancing errors are those which if not detected are not automatically counterbalanced
or corrected in the next accounting period. In other words, if the net income of one year is understated
or overstated, the net income of subsequent year is not affected.

EFFECTS OF NON-COUNTER-BALANCING ERRORS:

The income statement of the period in which the error is committed is incorrect but the succeeding
income statement is not affected.
The statement of financial position of the year of error and succeeding statements of financial position
are incorrect until the error is corrected.
Non-counter-balancing errors usually include misstatement of depreciation and amortization.
Recall: Counterbalancing and non-counter balancing errors are corrected by RETROSPECTIVE
RESTATEMENT. Retrospective restatement means correcting the recognition, measurement and
disclosure of amounts of elements of financial statements as if a prior period error had never occurred.

RECALL:
'Third' Statement of Financial Position
A statement of financial position as at the beginning of the PRECEDING (PREVIOUS) period is
included in the complete set of financial statements when an entity:
(a) applies an accounting policy retrospectively;
(b) makes a retrospective restatement of items in its financial statements, or
(c) when it reclassifies items in its financial statements as specified in PAS 1.
 EXAMPLE 1: Non-counterbalancing Errors
Assume as entity acquired an Office Equipment for P300,000 with a useful life of 3 years and nil
residual value, using straight-line method, the annual depreciation should have been
P100,000 (P300,000/3). The entity's failure to recognize depreciation expense on this
asset will have the following effect on profit and retained earnings:
Assuming prior period books are already closed, the correcting entry depending on when
the error was discovered follows (disregarding income taxes):

Year 1 Year 2 Year 3

Profit Over by P100,000 Over by P100,000 Over by P100,000
RE, End Over by P100,000 Over by P200,000 Over by P300,000

Error discovered in Y1: Error discovered in Y2: Error discovered in Y3: Error discovered in Y4:
Depn. Exp P100K Depn. Exp P100K Depn. Exp P100K RE P300K
AD P100K RE P100K RE P200K AD P300K
AD P200K AD P300K

For financial reporting In relation to Y1 error, the In relation to Y1 and Y2 errors,

purposes, the entity should entity should restate the the entity should restate the
restate Y1 FS to correct the opening balance of AD and RE opening balance of AD and RE of
misstatement of depreciation in of Y2. Y3.
Y1 and AD at the end of Y1.
Present a third statement of Present a third statement of
financial position as at the financial position as at the
beginning of Y2. beginning of Y3.

Restate Y2 FS to correct the Restate Y3 FS to correct the

misstatement of depreciation misstatement of depreciation in
in Y2 and AD at the end of Y2. Y3 and AD at the end of Y3.

EXAMPLE 2: Counterbalancing and Non-counterbalancing Errors

ABC Co. reported profits of P 1,000,000 and P2,000,000 in 20x1 and 20x2 respectively. In 20x3, the
following prior period errors were discovered:
a) The inventory on December 31, 20x1 was understated by P50,000.
b) An equipment with an acquisition cost of P300,000 was erroneously charged as expense in
20x1. The equipment has an estimated useful life of 5 years with no residual value. ABC Co.
provides full year depreciation in the year of acquisition.
The unadjusted balances of retained earnings are P2,200,000 and P4,200,000 as of December 31,
20x1 and 20x2, respectively.
Requirements:
a. How much are the correct profits in 20x1 and 20x2, respectively?
b. How much are the correct retained earnings in 20x1 and 20x2, respectively?
Solution:
a) Correct Profits
20x1 20x2
Unadjusted Profits: P 1,000,000 P 2,000,000
Corrections:
a) Understatement of December 31, 20x1 inventory 50,000 (50,000)

b) Equipment ➢ Capitalizable costs charged as expense 300,000

➢ Depreciation Expense not recognized (60,000) (60,000)
Net Adjustment to Profit: 290,000 (110,000)
Correct Profits: P 1,290,000 P 1,890,000

Notice that the effect of the error on the inventory in 20x1 has counterbalanced (i.e., automatically
reversed) in the immediately following year (i.e., 20x2) while the effect of the error on the equipment
did not counter-balanced in the immediately following period.

b) Correct RE
20x1 20x2
Unadjusted RE: P 2,200,000 P 4.200,000
Corrections:
c) Understatement of December 31, 20x1 inventory 50,000 No effect
 d) Equipment ➢ Capitalizable costs charged as expense 300,000
➢ CUMULATIVE Depreciation Expenses not recognized (60,000) (120,000)
Net Adjustment to Profit: 290,000 180,000
Correct Profits: P 2,490,000 P 4,380,000

Notice the following:

➢ The error in the 20x1 inventory has no effect on the December 31, 20x2 retained earnings
because its effect has already counter-balanced.

➢ The 20x2 year-end retained earnings is affected only by the non-counter balancing error (i.e.,
error in equipment).
EXAMPLE 3: Counterbalancing and Non-counterbalancing Errors
ABC Co. reported profits of P400,000 and P600,000 in 20x1 and 20x2, respectively. In 20x3, the
following prior period errors were discovered:
a) Prepaid supplies in 20x1 were overstated by P20,000.
b) Accrued salaries payable in 20x1 were understated by P40,000.
c) Repairs and maintenance expenses in 20x1 amounting to P 100,000 were erroneously
capitalized and being depreciated over a period of 4 years.
The unadjusted balances of retained earnings are P1 and P2,200,000 as of December 31 , 20x1 and
20x2, respectively.
Requirements:
a. How much are the correct profits in 20x1 and 20x2, respectively?
b. How much are the correct retained earnings in 20x1 and 20x2, respectively?

a) Correct Profits
20x1 20x2
Unadjusted Profits: P 1,000,000 P 2,000,000
Corrections:
a. Overstatement of 20x1 Prepaid Assets (20,000) 20,000
b. Understatement of 20x1 Accrued Salaries (40,000) 40,000

c. Repairs and ➢ Expenses erroneously capitalized (100,000) -

Maintenance
Expense
➢ Depreciation recognized on repair 25,000 25,000
costs (P100,000/4)
Net Adjustment to Profit: (135,000) 85,000
Correct Profits: P 265,000 P 685,000

b) Correct RE
20x1 20x2
Unadjusted Profits: P 1,000,000 P 2,000,000
Corrections:
a. Overstatement of 20x1 Prepaid Assets (20,000) No effect
b. Understatement of 20x1 Accrued Salaries (40,000) No effect

c. Repairs and Maintenance Expense ➢ Expenses erroneously (100,000) (100,000)

capitalized
➢ CUMULATIVE depreciation 25,000 50,000
recognized on repair costs
(P100,000/4)
Net Adjustment to Profit: (135,000) (50,000)
Correct Profits: P 1,465,000 P 2,150,000

Alternative Solution:

20x1 20x2
Unadjusted RE: P 1,600,000 P 2,200,000
Net Adjustment to 20x1 profit (135,000) (135,000)
Net Adjustment to 20x2 profit - 85,000
Corrected RE: P 1,465,000 P 2,150,000
 SUMMARY:
➢ The hierarchy of financial reporting standards:

1. PFRSs comprising PAS, PFRSs, and Interpretations

2. Management's judgment
When making the judgment:
Management shall consider the following:
a) Requirements in other PFRSs dealing with similar transactions
b) Conceptual Framework
Management may consider the following:
a) Standards issued by other standard-setting bodies that use a similar conceptual
framework.
b) Other accounting literature and industry practices.

➢ The two types of accounting changes are (a) change in accounting policy and (b) change in
accounting estimate.
➢ Accounting policies are those adopted by an entity in preparing and presenting its financial
statements. Such accounting policies shall be applied consistently.
➢ Accounting policies shall be changed only when the change (a) is required by PFRSs or (b)
results in a more relevant and reliable information.

Scope of PAS 8 Description Accounting Treatment Effect of Adjustment

1) Change in Accounting Change in Measurement Basis a) Transitional provision On RE, Beg. If
Policy b) Retrospective application accounted for
c) If (b) is impracticable, retrospectively.
prospective application

2) Change in Accounting Changes in the Realization (or a) Prospective Application In P/L of Current
Estimate Incurrence) of Expected Inflow Period or Current and
(or Outflow) of Economic Future Periods if the
Benefits from Assets (or change affects both.
Liabilities)

3) Correction of Prior Period Intentional and Unintentional a) Retrospective On RE, Beg. If

Error Misapplication of Principles, Restatement accounted for
Misinterpretation of Facts and b) If (a) is impracticable, retrospectively.
Mathematical Mistakes prospective application

➢ When it is difficult to distinguish change in accounting policy from a change id accounting

estimate, the change is treated as a change in an accounting estimate.
➢ A voluntary change in accounting policy is accounted for by retrospective application. Early
application of a PFRS is not a Voluntary change in accounting policy.
➢ Counterbalancing errors automatically reverse in subsequent Period if not corrected, non-
counterbalancing errors do. not automatically reverse in subsequent period. Relationships
between accounts:
If ending inventory is understated, profit is also understated — Direct relationship.
If an asset-related account is understated, profit is also understated - Direct relationship.
➢ Financial statements of subsequent periods need not repeat the disclosures required for a
change in accounting policy and the correction of a prior period error.