Correction of Errors

Discussion Outline
 Effect on profit of omission of accruals and deferrals

 Effect on profit of omission of trade A/R & advances from customer

 Effect on profit of omission of trade A/P

 Effect on profit of erroneous inventory

 Effect on profit of non counter balancing errors

 Effect on working capital of error on current asset and current liability

Omission (understatement) of Accruals & Deferrals
Omission of Entry when paid or Correct adjusting entry Profit on the year Profit the
collected (cash basis) omitted at year end of omission following year

Unearned Dr. Cash Dr. Rent income Overstated Understated:

income Cr. Rent income Cr. Unearned income Adjustment: (–) Adjustment: (+)

Accrued No entry Dr. Interest receivable Understated Overstated

income Cr. Interest income Adjustment: (+) Adjustment: (–)

Prepaid Dr. Insurance expense Dr. Prepaid insurance Understated Overstated

expense Cr. Cash Cr. Insurance expense Adjustment: (+) Adjustment: (–)

Accrued No entry Dr. Utilities expense Overstated Understated

expense Cr. Utilities payable Adjustment: (–) Adjustment: (+)
Guide

Relation to Profit Relation to Profit

@ year of error @ year of error
Asset Direct (same effect) Liability Inverse (opposite effect)

Overstated Overstated Profit Overstated Understated Profit

Asset Adjustment = (–) Liability Adjustment = (+)

Understated Understated Profit Understated Overstated Profit

Asset Adjustment = (+) Liability Adjustment = (-)
 2020 2021 2022

Unadjusted net(loss) income 240,000 (120,000) 200,000

Omission of prepaid expense 29,000 (29,000)
30,000 (30,000)
34,000
Omission of unearned revenue (20,000) 20,000
(28,000) 28,000
(15,000)
Omission of accrued expense (27,500) 27,500
(25,000) 25,000
(27,000)
Omission of accrued revenue 42,500 (42,500)
45,000 (45,000)
41,000
Adjusted profit 264,000 (122,000) 211,000
Discussion Outline
 Effect on profit of omission of accruals and deferrals

 Effect on profit of omission of trade A/R & advances from customer

 Effect on profit of omission of trade A/P

 Effect on profit of erroneous inventory

 Effect on profit of non counter balancing errors

 Effect on working capital of error on current asset and current liability

Omission of Trade A/R & Advances from Customer
Omission of Entry made when goods Entry made when cash is Profit on the year Profit the
were delivered at year of collected the following of omission following year
omission year

Trade A/R No Entry Dr. Cash Understated Overstated

Cr. Sales Adjustment: (+) Adjustment: (–)

Dr. Trade/AR Dr. Cash

Should be:
Cr. Sales Cr. Trade/AR

Entry made when goods

Omission of Entry made when cash is were delivered the Profit on the year Profit the
collected in advance following year of omission following year

Advances from Dr. Cash No entry Overstated Understated

customer Cr. Sales Adjustment: (–) Adjustment: (+)

Dr. Cash Dr. Advances from

Should be:
Cr. Advances from Customer
Customer Cr. Sales
Discussion Outline
 Effect on profit of omission of accruals and deferrals

 Effect on profit of omission of trade A/R & advances from customer

 Effect on profit of omission of trade A/P

 Effect on profit of erroneous inventory

 Effect on profit of non counter balancing errors

 Effect on working capital of error on current asset and current liability

Inventory Error
BCOSP
ENS
Profit Year of Error
Inventory, beg XX Inverse
Add: Purchases XX Inverse Counterbalance
Less: Inventory, end (XX) Direct Counterbalance

CGS XX
Discussion Outline
 Effect on profit of omission of accruals and deferrals

 Effect on profit of omission of trade A/R & advances from customer

 Effect on profit of omission of trade A/P

 Effect on profit of erroneous inventory

 Effect on profit of non counter balancing errors

 Effect on working capital of error on current asset and current liability

Non-counterbalancing Error

 Recording as outright expense of prepaid asset consumable for more than 1

year

 Recording as income the unearned income that will be earned in more than 1
year

 Capital expenditure recorded as outright expense

 Revenue expenditure erroneously capitalize

 Error on depreciation
Non-counterbalancing Error
 Recording as outright expense of prepaid asset consumable two years or more

Net income

Year of error
Year 1 Year 2 Year 3
Add back expense recorded XX - - Made

Expense incurred (consumed) (XX) (XX) (XX) Should be

Non-counterbalancing Error
 Recording as income the unearned income that will be earned in two years or more

Net income

Year of error
Year 1 Year 2 Year 3
Deduct income recorded (XX) - - Made

Record income earned XX XX XX Should be

Non-counterbalancing Error
 Capital expenditure recorded as outright expense

Net income

Year of error
Year 1 Year 2 Year 3
Add back expense recorded XX - - Made

Deduct depreciation expense (XX) (XX) (XX) Should be

Non-counterbalancing Error
 Revenue expenditure erroneously capitalize

Net income

Year of error
Year 1 Year 2 Year 3
Add back depre. recorded XX XX XX Made

Deduct outright expense (XX) - - Should be

Numbers 04, 05 and 06

2016 2017 Cumulative

Ending inventory - 2016 48,000 (48,000)

Ending inventory - 2017 (40,500)

Depreciation - 2016 (11,500)

Numbers 04, 05 and 06

 Recording as outright expense of prepaid asset consumable two years or more

Net income

Year of error
Year 1 Year 2 Year 3
Add back expense recorded 330,000
XX - - Made

Expense incurred (consumed) (110,000)

(XX) (110,000)
(XX) (110,000)
(XX) Should be
Numbers 04, 05 and 06

2016 2017 Cumulative

Ending inventory - 2016 48,000 (48,000)

Ending inventory - 2017 (40,500)

Depreciation - 2016 (11,500)

Add back expense recorded 330,000
Record true insurance expe. (110,000) (110,000)
Unrecorded gain on sale 75,000
Net error 256,500 (123,500) 133,000
Numbers 04, 05 and 06

Working
Capital
Current Asset Direct
Current Liability Inverse
Numbers 04, 05 and 06

Working
Capital
Overstatement of inventory 40,500 over
Understatement of prepaid asset 110,000 under
Understatement of cash 75,000 under
Working capital 144,500 under
 2019 2020 2021 2022
Unadjusted net income 120,000 88,000 104,000 120,000
Omission of prepaid expense 14,400 (14,400)
11,200 (11,200)
8,000 (8,000)
9,600
Omission of unearned income (6,400) 6,400
(4,800)
Omission of accrued expense (3,200) 3,200
(1,200) 1,200
(1,600) 1,600
(800)
Omission of accrued income 2,000 (2,000)
2,400
Overstated inventory (112,000) 112,000
(128,000) 128,000
Understated inventory 96,000 (96,000) 144,000
Numbers 07, 08, 09, 10, 11 and 12

2019 2020 2021 2022

Add back recorded depreciation (made) 10,000 10,000 10,000 10,000

Deduct repair expense (50,000) -- -- --

Adjustment to profit (40,000) 10,000 10,000 10,000

Unadjusted net income 120,000 88,000 104,000 120,000
Omission of prepaid expense 14,400 (14,400)
11,200 (11,200)
8,000 (8,000)
9,600
Omission of unearned income (6,400) 6,400
(4,800)
Omission of accrued expense (3,200) 3,200
(1,200) 1,200
(1,600) 1,600
(800)
Omission of accrued income 2,000 (2,000)
2,400
Overstated inventory (112,000) 112,000
(128,000) 128,000
Understated inventory 96,000 (96,000) 144,000
Wrong capitalization (40,000) 10,000 10,000 10,000
Numbers 07, 08, 09, 10, 11 and 12

2019 2020 2021 2022

Add back expense recorded (made) - - 90,000 -

Deduct depreciation (should be) - -- (30,000) (30,000)

Adjustment to profit - - 60,000 (30,000)

Unadjusted net income 120,000 88,000 104,000 120,000
Omission of prepaid expense 14,400 (14,400)
11,200 (11,200)
8,000 (8,000)
9,600
Omission of unearned income (6,400) 6,400
(4,800)
Omission of accrued expense (3,200) 3,200
(1,200) 1,200
(1,600) 1,600
(800)
Omission of accrued income 2,000 (2,000)
2,400
Overstated inventory (112,000) 112,000
(128,000) 128,000
Understated inventory 96,000 (96,000) 144,000
Wrong capitalization (40,000) 10,000 10,000 10,000
Wrong non capitalization -- -- 60,000 (30,000)
Adjusted profit 187,200 (115,600) 158,800 372,200
Numbers 07, 08, 09, 10, 11 and 12

Made VS. Should Be Analysis

Made Should be Adjust.

Profit 2019 120,000 187,200

Profit 2020 88,000 (115,600)

Profit 2021 104,000 158,800

RE 1/1/21 312,000 230,400 81,600

 Working
Capital
Understatement of prepaid asset 9,600 under
Understatement of unearned income 4,800 over
Understatement of accrued expense 800 over
Understatement of accrued income 2,400 under
Understatement of inventory 144,000 under
Understatement of Working Capital 150,400 under
 Made VS. Should Be Analysis
Year of Error (2019) Year of Error Next Year (2020) Next Year
Before Closing After Closing Before Closing After Closing

Made - - Utilities Expense xx Retained Earnings xx

Cash xx Utilities Expense xx

Utilities Expense xx Retained Earnings xx Utilities Payable xx

Should be Utilities Payable xx Utilities Expense xx Cash xx -

Utilities Expense xx Retained Earnings xx Retained Earnings xx

Correcting -
Utilities Payable xx Utilities Payable xx Utilities Expense xx
Discussion Outline
 Effect on profit of omission of accruals and deferrals

 Effect on profit of omission of trade A/R & advances from customer

 Effect on profit of omission of trade A/P

 Effect on profit of erroneous inventory

 Effect on profit of non counter balancing errors

 Effect on working capital of error on current asset and current liability