Financial statement error correction
/How to Correct Financial Statement Errors
An error correction is the correction of an error in previously issued financial statements. This can be an error in the recognition, measurement, presentation, or disclosure in financial statements that are caused by mathematical mistakes, mistakes in applying GAAP, or the oversight of facts existing when the financial statements were prepared. It is not an accounting change.
Prior Period Error Corrections
Prior period financial statements should be restated when there is an error correction. Restatement requires the accountant to:
Reflect the cumulative effect of the error on periods prior to those presented in the carrying amounts of assets and liabilities as of the beginning of the first period presented; and
Make an offsetting adjustment to the opening balance of retained earnings for that period; and
Adjust the financial statements for each prior period presented, to reflect the error correction.
If the financial statements are only presented for a single period, then reflect the adjustment in the opening balance of retained earnings.
Interim Period Error Corrections
If you correct an item of profit or loss in any interim period other than the first interim period of a fiscal year, and some portion of the adjustment relates to prior interim periods, then do the following:
Include that portion of the correction related to the current interim period in that period; and
Restate prior interim periods to include that portion of the correction applicable to them; and
Record any portion of the correct related to prior fiscal years in the first interim period of the current fiscal year.
Example of an Interim Period Error Correction
A company is preparing its quarterly financial statements for Q3. During this process, it discovers that it understated revenue by $100,000 in Q2 due to an error in recording a large customer contract. The controller reviews the transaction and confirms that the $100,000 was earned and should have been recognized in Q2. Management determines that the error is material to Q2's financial statements, but correcting it in Q3 will not mislead users of the financial statements. Based on this assessment, the accounting department corrects Q3's beginning retained earnings to accurately reflect the cumulative effect.
The company also includes a disclosure in the notes to its Q3 financial statements, describing the nature of the error, its impact, and the correction made. The disclosure is:
During the preparation of the Q3 financial statements, the Company identified an error in revenue recognition for Q2 of the current fiscal year. Revenue for Q2 was understated by $100,000 due to a clerical error in processing a customer contract. The cumulative effect of the error has been corrected in the current interim financial statements. As a result, beginning retained earnings for the nine months ended September 30, 20XX, were increased by $100,000.
As a result, the error is transparently corrected in the interim period without waiting until the annual reporting, providing stakeholders with accurate and reliable financial information.