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CORRECTION OF ERRORS Theories PDF
CORRECTION OF ERRORS Theories PDF
The financial records and reports are used as the basis of significant decisions
related to the operations of the enterprise. As a result, the reliability of the information
reflected in the financial records and reports is very important. However, reliability is not
the same as precision or accuracy of the information. No accounting system has been
devised that would come out with information that is exact, free from errors, and not be
subject to changes. No accountant can claim that his financial records and reports
contain accurate data.
Classifications of Errors
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The following do NOT constitute an accounting error:
Examples:
a. Change in the method of inventory pricing from the FIFO to
weighted average method;
b. Change in the method of accounting for long-term construction
contract from cost recovery method to percentage of completion
method (note: this will be discussed in Advanced Financial
Accounting);
c. The initial adoption of policy to carry assets at revalued amount is a
change in accounting policy to be dealt with as revaluation in
accordance with PAS 16;
d. Change from cost model to fair value model in measuring
investment property;
e. Change to a new policy resulting from the requirement of a new
PFRS.
Examples:
a. The estimate of the doubtful accounts is changed from 2% to 2.5% of
the outstanding accounts receivable.
b. The estimated useful life of the equipment is revised from 10 years to 8
years.
c. The amount provided for the product warranty expense is revised from
5% to 3% of net sales.
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dressing the financial statements in order to present a desired financial position or results
of operations.
Examples:
In order to report a bigger profit, the payments for expenses in the
current period are debited to asset accounts. The net profit is
intentionally overstated in order to impress the potential creditors, the
loan grantors, or the stockholders of the business enterprise.
Ending inventory is understated in order to understate the net income
thereby making the taxable income smaller.
A customer’s account is considered as bad debts in order to cover up
for misappropriated cash collections.
Fundamental Error
A fundamental error is any error that has significant or material effect on the financial
statements of one or more prior period, so that those financial statements can no longer
be considered reliable at the date of their issue. A fundamental error would significantly
affect the accounting records and reports, and may tend to mislead a data user. Some
examples of this are:
Big amounts of sales of the prior period is recorded as sales of the current
period;
Material overstatement or understatement in the depreciation of the
building in a prior period;
Major repairs incurred treated as expense.
There are errors that affect the balance sheet accounts only, the income
statement accounts only, or both of them. Some examples of commonly committed
fundamental errors, together with their effects on the current period and on the
succeeding period’s balances are presented in the following table.
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Effects of Selected Errors on the Balances of Two Successive Periods
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11. Earned portion of Income overstated no effect
the unearned income Net income overstated no effect
at the end of period 1 Retained earnings understated understated
was omitted (Liability Unearned income overstated overstated
method)
12. Prepaid expense Expenses overstated no effect
as of the end of Net income understated overstated
period 1 was not Retained earnings understated no effect
recorded (Expense Prepaid expenses understated overstated
method)
13. Expired portion of Expenses understated no effect
the prepaid expense Net income overstated no effect
at the end of period 1 Retained earnings overstated overstated
was omitted (Asset Prepaid expenses overstated overstated
method)
For the other kinds of errors, you may read from the copy of the discussion in
Mercedes B. Kimwell’s Constructive Accounting book.
CORRECTING AN ERROR
Good judgment, maturity and skill are necessary in deciding what course of action
is appropriate to take in case an error or errors are discovered. Some of the factors to
consider in deciding how to handle an error:
1. the period the error is discovered – in the period it was committed or in the
subsequent period
2. the nature and materiality of the error
C. Errors that affect both the balance sheet and the income statement
accounts
o Errors related to inventory
o Errors that affect the current period only
o Fundamental errors that affect one or more prior periods
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2. Sales on account was understated.
3. Cash purchases was understated.
4. Purchases on account was overlooked.
5. Prepaid taxes was overlooked.
6. Unearned income was understated.
7. Accrued wages was understated.
8. Accrued interest income was understated.
9. Doubtful accounts was not adjusted.
Depreciation of the equipment was
10.
understated.
B. The following errors were discovered before preparing the closing entries of 2011 nominal accounts.
Indicate the effects of each error on the net income of 2009, 2010 and 2011. For your answer, write
the words overstated, understated, no effect, or it depends in each space provided.
Net income
Error
2009 2010 2011
1. Ending inventory of 2010 was overstated.
2. Ending inventory of 2011 was understated.
3. Sales of 2009 was taken up in 2010.
4. Sales of 2010 was taken up in 2011.
5. Sales of 2010 was taken up in 2009.
6. Sales of 2011 was taken up in 2010.
7. Purchases of 2009 was taken up in 2010.
8. Purchases of 2010 was taken up in 2011.
9. Purchases of 2011 was taken up in 2010.
Accrued expenses at the end of 2009 was
10.
overstated.
Accrued expenses at the end of 2010 was
11.
understated.
Accrued expenses at the end of 2011 was
12.
overstated.
Prepaid expenses at the end of 2009 was
13.
understated.
Prepaid expenses at the end of 2010 was
14.
overstated.
Prepaid expenses at the end of 2011 was
15.
overstated.
Accrued income at the end of 2009 was
16.
overstated.
Accrued income at the end of 2010 was
17.
understated.
Accrued income at the end of 2011 was
18.
overstated.
Unearned income at the end of 2011 was
19.
understated.
Unearned income at the end of 2010 was
20.
understated.
Unearned income at the end of 2011 was
21.
understated.
22. Depreciation of 2009 was overstated.
23. Depreciation of 2010 was understated.
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24. Depreciation of 2011 was overstated.
25. Doubtful accounts of 2009 was not taken up.
26. Doubtful accounts of 2010 was not taken up.
27. Doubtful accounts of 2011 was not taken up.
Further reading/computations:
References:
Kimwell, M. (2007) Constructive Accounting
Valix, C.T., et. al. (2019) Intermediate Accounting Volume 3
END
_____________________________
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– Steve Jobs
“Hard work beats talent when talent does not work hard.”
“I think goals should never be easy, they should force you to work, even if they uncomfortable at the time.”
– Michael Phelps
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