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Notes in Auditing Problems - Correction of Errors
Notes in Auditing Problems - Correction of Errors
Definition of Terms
• Accounting policies: specific principles, bases, conventions, rules and practices adopted
by an enterprise in preparing and presenting the financial statements.
• Fundamental errors: are errors discovered in the current period with such significance,
that the financial statements of one or more prior periods can no longer be considered to
have been reliable at the date of their issue.
Accounting Procedure:
Benchmark treatment
A change in accounting policy/principle should be applied retroactively unless the
amount of any resulting adjustment that relates to prior periods is not reasonably
determinable. Any resulting adjustment should be reported as an adjustment to the
opening balance of the retained earnings. Comparative information should be restated
unless it is impracticable to do so.
Accounting Procedure:
a. Report current and future financial statements on the new basis.
b. Present prior period financial statements as previously reported.
c. Make no adjustment to current period opening balances.
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CORRECTION OF ERRORS
No company whether large or small is immune from errors. Errors may be intentional or
unintentional. Intentional errors are significant because of the presence of fraud or intent to
deceive. These errors are made for the purpose of concealing fraud or misappropriation, evading
taxes, manipulating or window-dressing the company's financial statements. Unintentional
errors were not deliberately committed. They result from carelessness or ignorance on the part
of the company's personnel or it may result from poor internal control.
The risk of material errors may be minimized through the installation of good internal
control and the application of sound accounting procedures. Prior period adjustments, also
called fundamental errors are reported in the current year as adjustment in the beginning balance
of the Retained Earnings account. Prior period statements should be restated to correct the error
when comparative statements are prepared.
Accounting Procedure:
1. If detected in the period the error occurred, correct the accounts through normal
accounting cycle adjustments.
2. If detected in subsequent period, adjust errors by making prior period adjustments
directly to Retained Earnings or restate the beginning balance of the Retained
Earnings account.
3. Correct all previously presented prior period statements.
TYPES OF ERRORS
This type of error refers to improper classification of real accounts such as assets,
liabilities or stockholders' equity accounts. They have no effect on net income
This type of error affects only the presentation of nominal accounts in the Income
Statement. It involves the improper classification of revenues and expenses accounts, hence,
only the details of the Income Statement are misstated. A reclassifying entry is necessary only if
the error is discovered in the same year it is committed. It has no effect on the Balance sheet and
in the Income Statement. If the error is discovered in a subsequent year, no classification entry is
necessary.
This affects both the balance Sheet and the Income Statement because they result in
the misstatement of net income.
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Classifications of Combined Balance Sheet and Income Statement Errors:
GUIDELINES
• Books are open
1. If the error is already counterbalanced and the company is in the second
year, an entry is necessary to correct the current period and to adjust the
beginning balance of the Retained earnings.
2. If the error is not yet counterbalanced, an entry is necessary to adjust the
beginning balance of the Retained earnings and correct the current
period.
• Books are closed
1. If the error is already counterbalanced, no entry is necessary.
2. If the error is not yet counterbalanced, an entry is necessary to adjust the
present balance of the Retained earnings.
END
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