LECTURE ON ERROR CORRECTION
Error refers to an unintentional misstatement in the financial statements including the omission of an amount or of its
disclosure, including:
1. A mistake in the gathering and/or processing of data from which the financial statements are presented.
2. An incorrect accounting estimate arising from an oversight or misinterpretation of facts.
3. A mistake in the application of accounting principles relating to recognition, measurement, classification,
presentation and disclosure.
An error is termed as a prior period error if it was committed on a previous period. These are omissions from, and
misstatement in the entity financial statement for one or more prior period arising from a failure to use or misuse of
reliable information that:
1. Was available when financial statements for those periods were authorized for issue, and
2. Could reasonably be expected to have been obtained and considered in the preparation and
presentation of those financial statements.
An error may be due to the (a) effects of mathematical mistakes, (b) mistakes in applying accounting policies and (c)
oversight or misinterpretations of facts and (d) fraud.
The standard mentioned that an entity shall correct material prior period errors retrospectively in the first set of
financial statements authorized for issue after their discovery by:
1. Restating the comparative amounts for the prior period presented in which the error occurred, or
2. If the error occurred before the earliest period prior period presented, restate the opening balances of
the assets, liabilities and equity account for the earliest prior period presented.
However, retrospective restatement is not available if such is impracticable to determine either the period specific
effects or the cumulative effect of the error. Hence, when it is impracticable to determine the period specific effects,
the entity shall restate the opening balances of the assets, liabilities and equity account for the earliest period for
which retrospective restatement is practicable. Also, if it is impracticable to determine the cumulative effect at the
beginning of the current period of an error on all prior periods, the entity shall restate the comparative information
to correct the error prospectively from the earliest practicable date.
An error may be termed as:
1. Balance sheet or statement of financial statement errors.
2. Income statement errors.
3. Combination of Balance Sheet and Income Statement which may be a:
Counterbalancing Error, or
Non-counterbalancing Error
Basic concepts of the effect of an error in the net income:
Nature Effect Relationship
Understatement of Sale Understatement Direct
Understatement of Cost of Sale Overstatement Indirect (Inverse)
Understatement of Expenses Overstatement Indirect (Inverse)
Basic concepts of the effect of an error on the cost of sale
Nature Effect Relationship
Understatement of Beginning Inventory Understated Direct
Understatement of Net Purchases Understated Direct
Understatement of Ending Inventory Overstated Indirect (Inverse)
Basic concepts of the effect of an error in the working capital:
Nature Effect Relationship
Overstatement of Current Asset Overstated Direct
Overstatement of Current Liability Understated Indirect (Inverse)
A working capital is the difference between a company current asset and its current liability.
Balance Sheet Error (Statement of Financial Statement Error):
A balance sheet error affects only a balance sheet account which may only need for a reclassification of account to
reflect its adjusted balances. However, if the error was committed in a prior period and was discovered on a
subsequent period, the company need to restate the prior period for comparative presentation purposes.
Illustrative Problem 1:
Karen Company erroneously debited the Land account on its purchased of an equipment in the amount of Php
10,000.
a. Adjusting entry if the error was committed on the year of
purchased: Equipment Php 10,000
Land Php 10,000
b. Adjusting entry of the error was discovered on the period subsequent on the year of
purchased: EquipmentPhp 10,000
Land Php 10,000
Take note that an error in the balance sheet remains to be an error until the year it was corrected.
Illustrative Problem 2:
Karen Company reported the following results of its operation for the years 2018 and 2019:
2018 - Php 300,000 2019 - Php 500,000
During the audit of the company's year ended December 2019 financial statement, the following errors are
discovered:
1. Accounts receivable of Php 15,000 was erroneously debited to notes receivable in 2018.
2. Accounts payable of 2018 was erroneously credited to notes payable, Php 10,000.
3. Land purchased in 2018 was erroneously debited to investment property, Php 10,000.
Required: Compute for the adjusted 2018 and 2019 net income and retained earnings for the year ending
December 2018 and 2019. In addition, prepare the adjusting entries for the year 2018 and 2019.
Solution:
Error 2018 Net Income 2019 Net Income 2018 Retained Earnings 2019 Retained Earnings
Php 300,000 Php 500,000 Php 300,000 Php 800,000
1. AR is understated. NR is
No Effect No Effect No Effect No Effect
overstated. No effect on Net Income.
2. AP is understated. NP is
No Effect No Effect No Effect No Effect
overstated. No effect on Net Income
3. Land in understated. Investment
property is overstated. No effect on No Effect No Effect No Effect No Effect
net income.
Adjusted Balances Php 300,000 Php 500,000 Php 300,000 Php 800,000
Adjusting entries:
A. If errors was discovered in 2018:
Accounts Receivable Php
15,000
Notes Receivable Php
15,000 Notes Payable Php 10,000
Accounts Payable Php 10,000
Land Php
10,000
Investment Property Php 10,000
B. If error was discovered in 2019:
Accounts Receivable Php 15,000
Notes Receivable Php
15,000
Notes Payable Php 10,000
Accounts Payable Php
10,000
Land Php 10,000
Investment Property Php 10,000
Considering the nature of the accounts in No. 1 and No. 2, no need for an adjusting entry for 2018 and 2019 if
payment was already made prior to year end of those years mentioned.
Income Statement Errors
This are errors affecting the company's revenues and expenses account. A company must make a reclassification
entry when it discovers the error in the error year. If the error discovered pertains to a prior year, the company
should restate the income statement of the prior year for comparative purposes.
Illustrative Problem 3:
Karen Company reported net income for the years 2018 and 2019 are as follows:
2018 - Php 300,000 2019 - Php 500,000
During the audit of the financial statement for the year ending 2019, the following errors was discovered:
1. Rent expense of Php 20,000 in 2018 was erroneously debited to interest expense.
2. Office supplies expense of Php 30,000 in 2018 was erroneously debited to purchases.
3. Sales of Php 50,000 in 2018 was credited to rent income.
Required: Compute for the adjusted net income for 2018 and 2019. In addition, determine the year end balances of
Retained Earnings for 2018 and 2019. Prepare as well the adjusting entries assuming the errors was discovered in
2018, 2019 and 2020.
Solution:
Error 2018 Net Income 2019 Net Income 2018 Retained Earnings 2019 Retained Earnings
Unadjusted Balances Php 300,000 Php 500,000 Php 300,000 Php 800,000
1. Rent Expense is understated.
Interest Expense is overstated. No No Effect No Effect No Effect No Effect
effect on net income.
2. Supplies expense is understated.
Purchases is overstated. No effect No Effect No Effect No Effect No Effect
on net income.
3. Sales is understated. Rent
income is overstated. No effect on No Effect No Effect No Effect No Effect
net income.
Adjusted Balance Php 300,000 Php 500,000 Php 300,000 Php 800,000
Adjusting entries:
A. If the error was discovered in
2018: Rent Expense Php
20,000
Interest Expense Php
20,000 Supplies Expense Php
30,000
Purchases Php
30,000 Rent Income Php 50,000
Sales Php 50,000
B. If the error was discovered in
2019: No adjusting entries
No adjusting entries for the errors because the effect of this error will offset as they are closed to the retained earnings.
Counterbalancing Error:
This are errors that will offset or be corrected over two accounting periods that may include the following:
1. Omission of deferred expense;
2. Omission of deferred income;
3. Omission of accrued expenses;
4. Omission of accrued revenues;
5. Overstatement or understatement of the following:
Sales not recorded in the first year and subsequently recorded the following year;
Purchases not recorded in the first year and subsequently recorded the following year;
Error affecting ending inventory.
Illustrative Problem 4:
The company paid a one year insurance premium effective July 2018. The entire amount was debited to expense
account and no adjustment was made at the end of 2018.
Solution:
Effect of the Error: 2018 2019
Insurance Expense Overstated Understated
Prepaid Insurance Understated No Effect
Net Income Understated Overstated
Retained Earnings, after closing Understated No Effect
Working capital at the end of the year
Understated No Effect
Illustrative Problem 5:
The company leased a portion of its building for Php 24,000. The term of the lease is one year ending June 30, 2019.
Collection of rent was credited to a rent revenue account. At the end of 2018, no entry was made to take up the
unearned portion of the amount collected.
Solution:
Effect of the Error 2018 2019
Rent revenue Overstated Understated
Unearned rent revenue Understated No Effect
Net income Overstated Understated
Retained earnings after closing Overstated No Effect
Working capital at the end of the year
Overstated No Effect
Illustrative Problem 6:
Accrued rent expenses of Php 10,000 was not recorded at the end of 2018.
Solution:
Effect of the Error 2018 2019
1. Rent expense Understated Overstated
2. Rent payable Understated No Effect
3. Net income Overstated Understated
4. Retained earnings after closing Overstated No Effect
5. Working capital at the end of the
Overstated No Effect
year
Illustrative Problem 7:
Accrued interest receivable of Php 5,000 was not recorded at the end of 2018.
Solution:
Effect of the Error 2018 2019
1. Interest income Understated Overstated
2. Interest receivable Understated No Effect
3. Net income Understated Overstated
4. Retained earnings after closing Understated No Effect
5. Working capital at the end of the
Understated No Effect
year
Illustrative Problem 8:
Sale of merchandise on account on December 29, 2018 amounting to Php 30,000 was not recorded until it was
collected on January 2019. The merchandise was properly excluded in the 2018 ending inventory.
Solution:
Effect of the Error 2018 2019
1. Sales Understated Overstated
2. Account receivable Understated No Effect
3. Net income Understated Overstated
4. Retained earnings after closing Understated No Effect
5. Working capital at the end of the
Understated No Effect
year
Illustrative Problem 9:
Purchase of merchandise on account on December 27, 2018 amounting to Php 100,000 was not recorded until it
was paid on January 2019. The merchandise was included in the 2018 ending inventory.
Solution:
Effect of the Error 2018 2019
1. Purchases Understated Overstated
2. Accounts payable Understated No Effect
3. Net income Overstated Understated
4. Retained earnings after closing Overstated No Effect
5. Working capital at the end of the
Overstated No Effect
year
Illustrative Problem 10:
On December 31, 2018 the ending inventory was overstated by Php 10,000.
Solution:
Effect of the Error 2018 2019
1. Cost of Sale Understated Overstated
2. Ending inventory Overstated No Effect
3. Net Income Overstated Understated
4. Retained earnings after closing Overstated No Effect
5. Working capital at the end of the
Overstated No Effect
year
Non-Counterbalancing Error:
This error do not offset in the next accounting period . Hence there is a need to make a correcting entries even if
they closed the books.
Illustrative Problem 11:
The company paid a 1-year rent effective May 1, 2018. The entire amount was debited to Prepaid Rent and no
adjustment was made at the end of 2018.
Solution:
Effect of the Error 2018 2019
1. Rent expense Understated Understated
2. Prepaid rent Overstated Overstated
3. Net income Overstated Overstated
4. Retained earnings after closing Overstated Overstated
5. Working capital at the end of the
Overstated Overstated
year
Illustrative Problem 12:
The company leased a portion of its building for Php 24,000. The term of the lease is 1 year ending May 30, 2019.
Collection of rent was credited to unearned rent revenue account. At the end of 2018, no entry was made to take
up the earned portion of the amount collected:
Solution:
Effect of the Error 2018 2019
1. Rent revenue Understated Understated
2. Unearned rent revenue Overstated Overstated
3. Net income Understated Understated
4. Retained earnings after closing Understated Understated
5. Working capital at the end of the
Understated Understated
year
Illustrative Problem 13:
Depreciation expense in 2018 was overstated by Php 3,000.
Solution:
Effect of the Error 2018 2019
1. Depreciation expense Overstated No Effect
2. Accumulated Depreciation Overstated Overstated
3. Net income Understated No Effect
4. Retained earnings after closing Understated Understated
Illustrative Problem 14:
Repair expense on the building amounting to Php 15,000 had been charged to the building account on January
1, 2018. Depreciation expense has been recorded in 2018 and 2019 based on the 4 year remaining useful life of
the building.
Solution:
Effect of the Error 2018 2019
1. Repair expense Understated No Effect
2. Depreciation expense Overstated Overstated
3. Net income Overstated Understated
4. Retained earnings after closing Overstated Overstated
5. Building (net) Overstated Overstated
6. Accumulated depreciation Overstated Overstated
Illustrative Problem 15:
Major improvements that extended the life of 4 years, on building amounting to Php 50,000 had been charged to
repair expense on January 1, 2018.
Solution:
Effect of the Error 2018 2019
1. Repair expense Overstated No Effect
2. Depreciation expense Understated Understated
3. Net income Understated Overstated
4. Retained earnings after closing Understated Understated
5. Building (net) Understated Understated
6. Accumulated depreciation Understated Understated
Illustrative Problem 16:
On January 1, 2018 an equipment costing Php 60,000 was sold for Php 30,000. At the date of sale, the equipment
had an accumulated depreciation of Php 15,000. The cash received was recorded as other income in 2018.
Solution:
Effect of the Error 2018 2019
1. Other income Overstated No Effect
2. Loss on sale Understated No Effect
3. Net income Overstated No Effect
4. Retained earnings after closing Overstated Overstated
5. Working capital at the end of the
No Effect No Effect
year
6. Equipment Overstated Overstated
7. Accumulated depreciation Overstated Overstated
