ERROR CORRECTION

➢Errors can arise in respect of the recognition, measurement,

presentation or disclosure of elements of financial statements.
Prior Period Errors
➢These are omissions and misstatements in the entity’s financial
statements for one or more periods arising from a failure to use or
misuse of reliable information that:
• Was available when financial statements for these periods were authorized
for issue
• Could reasonably be expected to have been obtained and taken into account
in the preparation and presentation of those financial statements

➢It include the effect of mathematical mistake, mistake in applying

accounting policy, oversight or misinterpretation of facts, and frauds.
Treatment of Prior Period Errors
➢An entity shall correct material prior period errors retrospectively in
the first set of financial statements authorized for issue after their
discovery.

➢The correction of a prior period error is an adjustment of the

beginning balance of Retained Earnings of the earliest period
presented.
Statement of Financial Position Errors
➢It affects real accounts only.

➢Errors may be due to improper classification of an asset, liability and

capital account

➢To correct this, an entry is simply made to reclassify the account

balances
Income Statement Errors
➢It affects nominal accounts only

➢There may be improper classification of revenue and expense accounts.

However, these errors have no effect on the statement of financial position
and on net income.

➢If the error is discovered in the same year it is committed, a reclassifying

entry is necessary

➢If the error is discovered in a subsequent year, no reclassifying entry is

necessary because the nominal accounts are already closed.
Combined Statement of Financial Position
and Income Statement Errors
➢They result in a misstatement of net income

➢For example, if accrued salaries payable is overlooked, the effects are:

• Salaries expense understated (income statement error)
• Liability understated (Statement of Financial Position error)
• Net Income overstated (income statement error)
• Retained earnings overstated (statement of financial position error)

➢They are classified as counterbalancing errors and

noncounterbalancing errors
Counterbalancing errors
➢These are errors which, if not detected, are automatically counterbalanced or corrected
in the next accounting period

➢Effects of counterbalancing errors

• Income statements for two successive periods are incorrect
• Statement of financial position at the end of the first period is incorrect
• Statement of financial position at the end of the second period is correct

➢Normally includes the misstatement of the following:

• Inventory, including purchases and sales
• Prepaid expense
• Accrued expense
• Deferred income
• Accrued income
Overstatement of ending inventory
ILLUSTRATION
On December 31, 2023, the physical count was overstated by P50,000.

If the books for 2024 have not been closed, the entry on December 31,
2024 to correct the error is:
Retained earnings P50,000
Inventory, Jan. 1, 2024 P50,000

If the books for 2024 have been closed, no entry is necessary because
the error is 2023 is counterbalanced in 2024.
Understatement of Ending Inventory
ILLUSTRATION
On December 31, 2023, the physical count was understated by P50,000

If the books for 2024 have not been closed, the entry to correct the error on
December 31, 2024 is:
Inventory, Jan. 1, 2024 P50,000
Retained earnings P50,000

If the books for 2024 have been closed, no entry is necessary because the
2023 error is counterbalanced in 2024
Understatement of Purchases
ILLUSTRATION
The entity failed to record a merchandise purchased in 2023 and the same
was recorded in 2024.

The physical inventory on December 31, 2023 was correctly stated.

If the books for 2024 have not been closed, the entry to correct the error on
December 31, 2024 is:
Retained earnings P50,000
Purchases P50,000
Overstatement of Purchases and Ending
Inventory
ILLUSTRATION
The entity recorded on December 31, 2023 P50,000 of purchases in transit to which
the entity has no title.

The same merchandise was included in the inventory on December 31, 2023.

If the books for 2024 have not been closed, the entries to correct the error on
December 31, 2024 are:
Purchases P50,000
Retained earnings P50,000
Retained earnings P50,000
Inventory, Jan. 1, 2024 P50,000
Understatement of sales
ILLUSTRATION
The entity failed to record sales of P50,000 in 2023 and the same was
recorded in 2024.
The physical inventory was correctly stated on December 31, 2023.

If the books for 2024 have not been closed, the entry to correct the
error on December 31, 2024 is:
Sales P50,000
Retained earnings P50,000
Overstatement of Sales and Understatement
of Ending Inventory
ILLUSTRATION
The entity recorded on December 31, 2023 P50,000 of sales in transit and to which
the customer had no title.
The cost of the merchandise was P30,000 and the same was excluded from the
December 31, 2023 inventory.

If the books for 2024 have not been closed, the entries to correct the error on
December 31, 2024 are:
Retained earnings P50,000
Sales P50,000
Inventory, Jan. 1, 2024 P30,000
Retained earnings P30,000
Failure to record prepaid expense
ILLUSTRATION
On January 1, 2023, the entity purchased an insurance for 2 years for
P50,000. The payment was debited to an expense and no adjustment
was made on December 31, 2023 for the prepaid insurance.

If the books for 2024 have not been closed, the entry to correct the
error on December 31, 2024 is:
Insurance P25,000
Retained earnings P25,000
Failure to record accrued expense
ILLUSTRATION
On December 31, 2023, accrued rent expense of P50,000 was not
recorded.

If the books for 2024 have not been closed, the entry to correct the
error on December 31, 2024 is:
Retained earnings P50,000
Rent expense P50,000
Failure to record a deferred income
ILLUSTRATION
On January 1, 2023, the entity received rent for 2 years in the amount
of P50,000. The same was credited to rent income and no adjustment
was made on December 31, 2023.

If the books for 2024 have not yet been closed, the entry to correct the
error on December 31, 2024 is:
Retained earnings P25,000
Rent Income P25,000
Failure to record accrued income
ILLUSTRATION
On December 31, 2023, accrued interest receivable of P50,000 was not
recorded.

If the books for 2024 have not been closed, the entry to correct the
error on December 31, 2024 is:
Interest Income P50,000
Retained earnings P50,000
Noncounterbalancing Errors
➢Errors which, if not detected, are not automatically counterbalanced
or corrected in the next accounting period.

➢Effects of noncounterbalancing errors

• Income statement of the period in which the error is committed is incorrect
but the succeeding income statement is not affected.
• Statement of financial position of the year or error and succeeding statement
of financial position are incorrect until the error is corrected.

➢The best example of this error is the misstatement of depreciation

Illustration
On January 1, 2023, the entity purchased an equipment with useful life of 5 years for P500,000 but the same was debited to repair
and maintenance expense.

If the books for 2024 have not been closed, the entries to correct the error on December 31, 2024 are:
Equipment P500,000
Retained earnings P500,000
Depreciation (500K / 5) P100,000
Retained earnings P100,000
Accumulated depreciation P200,000

If the books for 2024 have been closed, the entries to correct the error on December 31, 2024 are:
Equipment P500,000
Retained earnings P500,000
Retained earnings P200,000
Accumulated depreciation P200,000
Illustration
An entity reported net income for 2022 P3,000,000, 2023 P4,000,000,
and 2024 P3,500,000.

1. December 31, 2022 inventory overstated 120,000

2. December 31, 2024 inventory understated 210,000
3. December 31, 2022 accrued interest payable understated 40,000
4. December 31, 2024 accrued interest payable overstated 90,000
5. Depreciation for 2023 understated 180,000
 2022 2023 2024
Net Income per Book 3,000,000 4,000,000 3,500,000
1. Overstatement of 2022 inventory (120,000) 120,000
2. Understatement of 2024 inventory 210,000
3. Understatement of 2022 accrued interest (40,000) 40,000
payable
4. Overstatement of 2024 accrued interest 90,000
payable
5. Understatement of 2023 depreciation (180,000)
Corrected Net Income 2,840,000 3,980,000 3,800,000
Correcting entries on December 31, 2024
1. No adjustment. The overstatement of income in 2022 is counterbalanced by the understatement of income in 2023.
2. Inventory, December 31, 2024 210,000
Income summary P210,000
3. No adjustment.
4. Accrued interest payable 90,000
Interest expense 90,000
5. Retained earnings 180,000
Accumulated Depreciation 180,000