Error Correction

Introduction

Errors can arise in respect of the recognition,

measurement, presentation or disclosure of
elements of financial statements. Potential current
period errors discovered in that period are
corrected before the financial statements are
authorized for issue.

However, material errors are sometimes not

discovered until a subsequent period, and the prior
period errors discovered in that period are
corrected in the comparative information
presented in the financial statements for that
subsequent period
Prior period errors

Prior period errors

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:

a. Was available when financial statements for

these periods were authorized for issue.

b. Could reasonably be expected to have been

obtained and taken into accounts in the
preparation and presentation of those financial
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.
Statement of financial position errors

Statement of financial position errors affect the

statement of financial position or real accounts
only, meaning, improper classification of an asset,
liability and capital account.

In such a case, an entry is simply made to

reclassify the account balances.

For example, if preference share capital is

erroneously credited instead of ordinary share
capital, the reclassifying entry is debit preference
share capital and credit ordinary share capital.
Income statement errors

Income statement errors affect the income

statement or nominal accounts only, meaning, the
improper classification of revenue and expense
account.

Those errors have no effect on the statement of

financial position and on net income.

Thus, a reclassifying entry is necessary only if the

error is discovered in the same year it is
committed.
Income statement errors

Otherwise, if the error is discovered in a

subsequent year, no reclassifying entry is
necessary because the nominal accounts for the
current year are correctly stated.

For example, the entity erroneously debited

purchases instead of office supplies during 2023.

If the error is discovered in 2023, the reclassifying

entry is debit office supplies and credit purchases.

If the error is discovered in 2024, no reclassifying

entry is made. The office supplies account and
Combined statement of financial
position and income statement errors
These errors affect both the financial statement of
financial position and income statement because
they result in a
misstatement of net income.

For example, if accrued salaries payable is

overlooked, the effects are:
a. Salaries expense understated(income statement
error)
b. Liability understated(statement of financial
position error)
c. Net income overstated(income statement error)
d. Retained earnings overstated(statement of
Counterbalancing errors

are errors which, if not detected, are automatically

counterbalanced or corrected in the next
accounting period.

In other words, counterbalancing errors will be

offset or corrected over two periods or correct
themselves over two periods.
Effects of Counterbalancing errors

a. The income statements for two successive

periods are incorrect.
b. The statement of financial position at the end of
the first period is incorrect.
c. The statement of financial position at the end of
the second period is correct
Effects of Counterbalancing errors

This error normally include the misstatement of

the:

• Inventory, including purchases and sales.

• Prepaid expenses
• Accrued expenses
• Deferred income
• Accrued income
Overstatement of ending inventory

On December 31, 2022, the physical count was overstated

by P50,000.
If the books for 2023 have not been closed, the entry on
December 31, 2023, to correct the error is:

Retained Earnings 50,000

Inventory, January 1, 2023 50,000
Overstatement of ending inventory

The retained earnings account is debited because the net

income of 2022 was overstated. The inventory
account is credited because the ending inventory on
December 31, 2022, was overstated. If the books for 2023
have been closed, no entry is necessary because the error
in 2022 is counterbalanced in 2023.
Understatement of ending inventory

On December 31, 2022, the physical count was

understated by P50,000.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Inventory, January 1, 2023 50,000

Retained Earnings 50,000
Understatement of ending inventory

The inventory account is debited, and the retained earnings

account is credited because the ending inventory of 2022
was understated, resulting in a consequent understatement
of net income.

If the books for 2023 have been closed, no entry is

necessary because the 2022 error is counterbalanced in
2023.
Understatement of Purchases

The entity failed to record merchandise purchased in 2022,

but it was recorded in 2023. The physical inventory on
December 31, 2022, was correctly stated.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Retained Earnings 50,000

Purchases 50,000
Understatement of Purchases

The retained earnings account is debited because the net

income of 2022 was overstated.

The purchases account is credited because the purchase

pertains to 2022, but the same is recorded in 2023, thus
resulting in an overstatement of 2023 purchases.
If the books for 2023 have been closed, no entry is
necessary because the 2022 error is counterbalanced in
2023.

The purchases account in 2022 is understated, while the

purchases account in 2023 is overstated. Thus, they
equalize each other.
Overstatement of Purchases and Ending
Inventory
On December 31, 2022, the entity recorded P50,000 of
purchases in transit to which it had no title. The same
merchandise was included in the inventory on December
31, 2022.
If the books for 2023 have not been closed, the entries to
correct the error on December 31, 2023, are:
1. Purchases 50,000
Retained Earnings 50,000
2. Retained Earnings 50,000
Inventory, January 1, 2023 50,000
Overstatement of Purchases and Ending
Inventory
In the first entry, the purchases account is debited because
the purchase pertains to 2023 and was erroneously
recorded in 2022.

The retained earnings account is credited because the net

income of 2022 was understated by reason of overstated
purchases.
Overstatement of Purchases and Ending
Inventory
In the second entry, the retained earnings account is
debited, and the inventory account is credited because the
ending inventory of 2022 was overstated, resulting in an
overstatement of net income.

The net effect of the error is zero on net income and

retained earnings.

If the books for 2023 have been closed, no entry is

necessary because the 2022 error is counterbalanced in
2023.
Understatement of Sales

The entity failed to record sales of P50,000 in 2022, but the

same was recorded in 2023. The physical inventory was
correctly stated on December 31, 2022.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Sales 50,000
Retained Earnings 50,000
Understatement of Sales

The sales account is debited because the same pertains to

2022 and was recorded in 2023, thus overstating 2023
sales.

The retained earnings account is credited because the

2022 net income was understated.

If the books for 2023 have been closed, no entry is

necessary because the 2022 error is counterbalanced in
2023.
Overstatement of Sales and
Understatement of Ending Inventory
On December 31, 2022, the entity recorded P50,000 of
sales in transit, to which the customer had no title. The cost
of the merchandise was P30,000, and the same was
excluded from the December 31, 2022 inventory. If the
books for 2023 have not been closed, the entries to correct
the error on December 31, 2023, are:

Retained Earnings 50,000

Sales 50,000

Inventory, January 1, 2023 30,000

Retained Earnings 30,000
Overstatement of Sales and
Understatement of Ending Inventory
In the first entry, the retained earnings account is debited
because the 2022 net income was overstated. The sales
account is credited because the sale pertains to 2022 and
was erroneously recorded in 2023.

In the second entry, the inventory account is debited, and

the retained earnings account is credited because the 2022
net income was understated due to the understatement of
the 2022 ending inventory.

If the books for 2023 have been closed, no entry is

necessary because the 2022 error is counterbalanced in
2023.
Failure to Record Prepaid Expense

On January 1, 2022, the entity purchased insurance for two

(2) years for P50,000.
The payment was debited to an expense, and no
adjustment was made for the prepaid insurance on
December 31, 2022.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Insurance 25,000
Retained Earnings 25,000
Failure to Record Prepaid Expense

The insurance account is debited because the prepaid

insurance on December 31, 2022, becomes an expense in
2023.

The retained earnings account is credited because the

2022 net income was understated.

If the books for 2023 have been closed, no entry is

necessary because the error is counterbalanced.
Failure to Record Accrued Expenses

On December 31, 2022, accrued rent expense of P50,000

was not recorded.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Retained Earnings 50,000

Rent Expense 50,000
Failure to Record Accrued Expenses

The retained earnings account is debited because the net

income of 2022 was overstated.
The rent expense is credited because the accrual of 2022
was necessarily paid in 2023, and the same was debited to
the rent expense, thus overstating the rent expense of
2023.
If the books for 2023 have been closed, no entry is
necessary because the 2022 error is counterbalanced in
2023.
The net income of 2022 was overstated due to an
understatement of rent expense, while the 2023 net income
was understated due to an overstatement of rent expense.
Failure to Record a Deferred Income

On January 1, 2022, the entity received rent for two years

in the amount of P50,000.
The same was credited to rent income, and no adjustment
was made on December 31, 2022.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Retained Earnings 25,000

Rent Income 25,000
Failure to Record a Deferred Income

The retained earnings account is debited because the 2022

net income was overstated.

The rent income is credited because the unearned income

on December 31, 2022, becomes an income of 2023.

If the books for 2023 have been closed, no entry is

necessary because the 2022 error is counterbalanced in
2023.
Failure to Record Accrued Income

On December 31, 2022, accrued interest receivable of

P50,000 was not recorded.
If the books for 2023 have not been closed, the entry to
correct the error on December 31, 2023, is:

Interest Income 50,000

Retained Earnings 50,000
Failure to Record Accrued Income

The interest income is debited because the 2022 interest

accrual was necessarily received in 2023, and the same
was credited to interest income, thus overstating the 2023
interest income.

The retained earnings account is credited because the

2022 income was understated.

If the books for 2023 have been closed, no entry is

necessary because the 2022 error is counterbalanced in
2023.
Non-counterbalancing Errors

Non-counterbalancing errors are errors that, if not detected,

are not automatically counterbalanced or corrected in the
next accounting period. In other words, if the net income of
one year is understated or overstated, the net income of
the subsequent year is not affected.
Non-counterbalancing Errors

Effects of non-counterbalancing errors

1.The income statement of the period in which the error

was committed is incorrect, but the succeeding income
statement is not affected.
2.The statement of financial position of the year of error
and the succeeding statement of financial position is
incorrect until the error is corrected.
Non-counterbalancing Errors

On January 1, 2022, the entity purchased equipment with a

useful life of 5 years for P500,000, but the same was
debited for repair and maintenance.
If the books for 2023 have not been closed, the entries to
correct the error on December 31, 2023, are:

1. Equipment 500,000
Retained Earnings 500,000
2. Depreciation (500,000/5) 100,000
Retained Earnings 100,000
Accumulated Depreciation 200,000
Non-counterbalancing Errors

If the books for 2023 have been closed, the entries to

correct the error on December 31, 2023, are:

1. Equipment 500,000
Retained Earnings 500,000
2. Retained Earnings 200,000
Accumulated Depreciation 200,000
Correcting Entries on December 31,
2023
1. No adjustment. The overstatement of income in 2021 is
counterbalanced by the understatement of income in 2022.

2. Inventory - December 31, 2023 210,000

Profit or Loss 210,000

3. No adjustment. The overstatement of income in 2021 is

counterbalanced by the understatement of income in 2022.
Correcting Entries on December 31,
2023
4. Accrued Interest Payable 90,000
Interest Expense 90,000

5. Retained Earnings 180,000

Accumulated Depreciation 180,000

6. Accumulated Depreciation 30,000

Depreciation 30,000