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ERROR CORRECTION
Prior period errors • Treatment of prior period errors
Prior period errors – are omissions and • An entity shall correct material prior period
misstatements in the entity’s financial errors retrospectively in the first set of FS
statements for one or more periods arising a authorized for issue after their discovery.
failure to use or misuse of reliable information
that: • A prior period error shall be corrected by
retrospective restatement, meaning, if
a. Was available when FS for these periods comparative statements are presented, the
were authorized for issue. prior year statements are restated to correct
b. Could reasonably be expected to have the error.
been obtained and taken into account in • The correction of prior period error is an
the preparation and presentation of those adjustment of the beginning balance of
financial statements. retained earnings of the earliest period
It includes the effect of mathematical mistakes, presented
mistakes in applying accounting policies,
oversights or misinterpretation of facts, and
fraud.
 No adjustment if books are closed

• Statement of financial position errors Just Reclassify • Counterbalancing errors

• Statement of financial position errors affect • Counterbalancing errors – are errors which if
the statement of financial position or real not detected, are automatically
accounts only, meaning, the improper counterbalanced or corrected in the next
classification of an asset, liability and capital accounting period. In other words, these
account. In such a case, an entity is simply errors will be offset or corrected over two
made to reclassify the account balances periods or these errors correct themselves
over two periods.
• Income statement errors
• Income statement errors affect the income • Counterbalancing errors normally include the
statement or nominal accounts only, misstatement of the following: Examples of
counterbalnceing errors
meaning, the improper classification of • a. Inventory, including purchases and sales
revenue and expense accounts. These errors • b. Prepaid expense
have no effect on the statement of financial
position and on net income. Thus, a • c. Accrued expense
reclassifying entry is necessary only if the
error is discovered in the same year it is • d. Deferred income
committed. Reclassify if error discovered in • e. Accrued income
same year
• Effects of counterbalancing errors
End inv and NI = Directly Proportional
• a. The income statements for two successive periods are incorrect. Beg inv and COGS = Directly Proportional
• b. The statement of financial position at the end of the first period is incorrect. Beg inv and NI = Inversly Proportional
• c. The statement of financial position at the end of the second period is correct.
• Overstatement of ending inventory
• On December 31, 2018, the physical count was overstated by P50,000.
• If the books for 2019 have not been closed, the entry on December 31, 2019 to correct the error is:
• Retained earnings 50,000 Overstamtent = Debit RE
• Inventory, Jan. 1, 2019 50,000
• Notes: The retained earnings account is debited because the net income of 2018 was overstated. The
inventory account is credited because the ending inventory on December 31, 2018 was overstated.
cuz of counterbalancing
• If the books for 2019 have been closed, no entry is necessary because the error in 2018 is counterbalanced
in 2019. In other words, the ending inventory in 2018 becomes the beginning inventory in 2019. Thus, if the
beginning inventory of 2019 is overstated, cost of goods sold would be overstated.
Errors in 2018 and corrected in 2019
• Understatement of ending inventory Understatement : credit re • Understatement of purchases
• Illustration: On December 31, 2018, the physical count was • Illustration: The entity failed to record a merchandise
understated by P50,000. purchased in 2018. The is recorded in 2019. The physical
inventory on December 31, 2018 was correctly stated.
• Required: If the books for 2019 have not been closed, what is
the entry to correct the error on December 31, 2019? • Required: If the books for 2019 have not been closed, what is
the entry to correct the error on December 31, 2019?
• Inventory, January 1, 2019 50,000
• Retained earnings 50,000
• Retained earnings 50,000
• Purchases 50,000
• Notes:
• Notes:
• 1. The inventory account is debited and the retained earnings
account is credited because the ending inventory of 2018 was • 1. The retained earnings account is debited because net
understated with a consequent understatement of net income of 2018 was overstated.
income.
• 2. The purchases account is credited because the purchase
• 2. If the books for 2019 have been closed, no entry is pertains to 2018 and the same is recorded in 2019, thus
necessary because the 2018 error is counterbalanced in resulting to overstatement of 2019 purchases. If the books
2019. for 2019 have been closed, no entry is necessary because the
2018 error is counterbalanced in 2019.
• The purchases account in 2018 is understated while the
purchases account in 2019 is overstated. Thus, they equalize
each other.
 U ni
O ni
Combination• Overstatement of purchases and ending inventory • Understatement of sales
• Illustration: The entity recorded on December 31, 2018 • Illustration: The entity failed to record sales of P50,000 in
P50,000 of purchases in transit to which the entity had no 2018. The same was recoded in 2019. The physical inventory
title. The same merchandise was included in the inventory of was correctly stated on December 31, 2018.
December 31, 2018.
• Required: If the books for 2019 have not been closed, what is
• Required: If the books for 2019 have not been closed, what the entry to correct the error on December 31, 2019?
are the entries to correct the error on December 31, 2019:
• Sales 50,000
• 1. Purchases 50,000
• Retained earnings 50,000
• Retained earnings 50,000
• Notes:
• 2. Retained earnings 50,000
• 1. The retained earnings account is credited because the
• Inventory, January 1, 2019 50,000 2018 net income was understated. The sales account is
debited because the same pertains to 2018 and was recorded
• Notes: In the first entry, the retained earnings account is in 2019, thus overstating 2019 sales.
credited because the net income of 2018 was understated by
reason of overstatement of purchases. The purchases • 2. If the books for 2019 have been closed, no entry is
account is debited because the purchase pertains to 2019 necessary because the 2018 error is counterbalanced in
and erroneously recorded in 2018. In the second entry, the 2019. The sales account of 2018 was understated and the
retained earnings account is debited and the inventory sales account of 2019 overstated . They equalize each other.
account is credited because the ending inventory of 2018 was
overstated resulting to overstatement of net income.
• Overstatement of sales/Understatement of ending • Failure to record prepaid expenses
inventory
• Illustration: On January 1, 2018, the entity purchased an
• Illustration: The entity recorded on December 31, 2018 insurance for two years for P50,000. The payment was
P50,000 of sales in transit and to which the customer had no debited to an expense and no adjustment was made on
title. The cost of the merchandise was P30,000 and the same December 31, 2018 for the prepaid insurance.
was excluded from December 31, 2018 inventory.
• Required: If the books for 2019 have not been closed, what is
• Required: If the books have not been closed, what are the the entry the entry to correct the error on December 31,
entries to correct the error on December 31, 2019? 2019?
• 1. Retained earnings 50,000 • Entry made on January 1, 2018:
• Sales 50,000 • Insurance expense 50,000
• 2. Inventory, January 1, 2019 30,000 • Cash 50,000
• Retained earnings 30,000 • Entry that should be made on Dec. 31, 2018 (not recorded):
• Notes: In the first entry, the retained earnings account is • Prepaid insurance (50,000 / 2) 25,000
debited because the 2018 net income was debited. The sales
account is credited because the sale pertains to 2019 and • Insurance expense 25,000
was erroneously recorded in 2018. In the second entry, the
inventory account is debited and the retained earnings • Correcting entry in 2019:
account is credited because the 2018 net income was • Insurance expense 25,000
understated by reason of understatement of 2018 inventory.
The inventory account (January 1, 2019) is debited because • Retained earnings 25,000
the 2018 ending inventory is understated.
• Failure to record accrued expense • Failure to record deferred income
• Illustration: On December 31, 2018, accrued rent expense of P50,000 • Illustration: On January 1, 2018, the entity received rent for two years
was not recorded. in the amount of P50,000. The same was credited to rent income and
no adjustment was made on December 31, 2018.
• Required: If the books for 2019 have not been closed, what is the
entry to correct the error on December 31, 2019? • Required: If the books for 2019 have not been closed, what is the
entry to correct the error on December 31, 2019?
• Entry that should be made (not recorded):
• Entry made on January 1, 2018:
• Rent expense 50,000
• Cash 50,000
• Accrued rent 50,000
• Rent income 50,000
• Correcting entry on December 31, 2019:
• Entry that should be made on Dec. 31, 2018 (not recorded):
• Retained earnings 50,000
• Rent income (50,000 / 2) 25,000
• Rent expense 50,000
• Unearned rent 25,000
• Notes: The retained earnings account is debited because the net
income of 2018 was overstated. The rent expense is credited because • Correcting entry on December 31, 2019:
the accrual of 2018 necessarily was paid in 2019 and the same was
debited to rent expense, thus overstating the rent expense of 2019. If • Retained earnings 25,000
the books of 2019 have been closed, no entry is necessary because
the 2018 error is counter balanced in 2019. • Rent income 25,000
• Notes: The retained earnings account is debited because the 2018 net
income was overstated. The rent income is credited because the
unearned income because the unearned income on December 31,
2018 becomes an income of 2019.
 Failure to record accrued income • Non-counterbalancing errors:
• Illustration: On January 1, 2018, accrued interest receivable • Non-counter balancing errors are errors which if not
of P50,000 was not recorded. detected, are not automatically counter balanced or detected
in the next accounting period. In other words, if the net
• Required: If the books for 2019 have not been closed, what is income of one year is understated or overstated, the net
the entry to record the error on December 31, 2019? income of subsequent year in not affected.
• Entry that should be made ( not recorded): • Effects of non-counter balancing errors
• Accrued interest receivable 50,000 • 1. The income statement of the period in which the error is
committed is incorrect but the succeeding income statement
• Interest income 50,000 is not affected.
• Correct entry on December 31, 2019: • 2. The statement of financial position of the year of error and
• Interest income 50,000 succeeding statement of financial position are incorrect until
the error is corrected.
• Retained earnings 50,000
• The best example of a no n-counter balancing error is the
• Notes: The retained earnings account is credited because the misstatement of depreciation.
2018 income was understated. The interest income was
debited because the interest accrual of 2018 necessarily was
received in 2019 and the same was credited to interest
income, thus overstating the 2019 interest income.
• Misstatement of depreciation • 1. Correcting entries that should be made on December 31, 2019 if
the books in 2019 have not been closed:
• Illustration: On January 1, 2018, the entity purchased an equipment
with useful life of 5 years for P500,000 but the same was debited to • a. Equipment 500,000
repair and maintenance.
• Retained earnings 500,000
• Required:
• b. Depreciation (500,000 / 5) 100,000
• 1. If the books in 2019 have not been closed, what are the entries to
correct the error on December 31, 2019? • Retained earnings 100,000
• 2. If the books for 2019 have been closed, what are the entries to • Accumulated depreciation 200,000
correct the error on December 31, 2019?
• 2. Correcting entries that should be made on December 31, 2019 if
• Wrong entry made on January 1, 2018: the books for 2019 have been closed:
• Repairs and maintenance 500,000 • a. Equipment 500,000
• Cash 500,000 • Retained earnings 500,000
• Entry that should be made on January 1, 2018: • b. Retained earnings 200,000
• Equipment 500,000 • Accumulated depreciation 200,000
• Cash 500,000
• Entry that should be made on Dec 31, 2018 to record the depreciation:
• Depreciation (500,000 / 5) 100,000
• Accumulated Depreciation 100,000
• Problem 16-6
• Victoria Company revealed the following errors in the financial statements:
• Ending inventory Depreciation
• 2018 200,000 understated 50,000 understated
• 2019 300,000 overstated 100,000 overstated
• Required: At what amount should retained earnings be retroactively adjusted on January 1, 2020?
• Answer: Retained Earnings
• 2018 2019 January 1, 2020
• 2018 inventory understated 200,000 (200,000) -
• 2019 inventory overstated (300,000) (300,000)
• 2018 depreciation understated (50,000) ( 50,000)
• 2019 depreciation overstated 100,000 100,000
• (250,000)