ERROR CORRECTION meaning, the improper classification of an asset, liability

Prior Period Errors and capital account. In such a case, an entity is simply
made to reclassify the account balances
Prior Period Errors
are omissions and misstatements in the entity’s financial INCOME STATEMENT ERRORS
statements for one or more periods arising a failure to
use or misuse of reliable information that:
Income statement errors affect the income statement or
a. Was available when FS for these periods were nominal accounts only, meaning, the improper
authorized for issue. classification of revenue and expense accounts. These
b. Could reasonably be expected to have been errors have no effect on the statement of financial
obtained and taken into account in the preparation position and on net income. Thus, a reclassifying entry is
and presentation of those financial statements. necessary only if the error is discovered in the same year
it is committed.
It includes the effect of mathematical mistakes, mistakes
in applying accounting policies, oversights or
misinterpretation of facts, and fraud. COUNTERBALANCING ERRORS

Treatment of prior period errors Counterbalancing errors – are errors which if not
detected, are automatically counterbalanced or
 An entity shall correct material prior period errors
corrected in the next accounting period. In other words,
retrospectively in the first set of FS authorized for
these errors will be offset or corrected over two periods or
issue after their discovery.
these errors correct themselves over two periods.
 A prior period error shall be corrected by retrospective
restatement, meaning, if comparative statements are
Counterbalancing errors normally include the
presented, the prior year statements are restated to
misstatement of the following:
correct the error.
 The correction of prior period error is an adjustment of
• a. Inventory, including purchases and sales
the beginning balance of retained earnings of the
• b. Prepaid expense
earliest period presented
• c. Accrued expense
• d. Deferred income
Statement of Financial Position Errors
• e. Accrued income
Statement of financial position errors affect the
statement of financial position or real accounts only,
 Required: If the books for 2019 have not been closed,
Effect of Counterbalancing Errors: what is the entry to correct the error on December 31,
2019?
a) The income statements for two successive periods
are incorrect. Inventory, January 1, 2019 50,000
b) The statement of financial position at the end of the Retained earnings 50,000
first period is incorrect.
c) The statement of financial position at the end of the Notes:
second period is correct. 1. The inventory account is debited and the retained
earnings account is credited because the ending
Overstatement of Ending Inventory inventory of 2018 was understated with a
consequent understatement of net income.
On December 31, 2018, the physical count was overstated 2. If the books for 2019 have been closed, no entry is
by P50,000. necessary because the 2018 error is
counterbalanced in 2019.
If the books for 2019 have not been closed, the entry on
December 31, 2019 to correct the error is: Understatement of Purchases

Retained earnings 50,000 Illustration: The entity failed to record a merchandise

Inventory, Jan. 1, 2019 50,000 purchased in 2018. The is recorded in 2019. The physical
inventory on December 31, 2018 was correctly stated.
Notes: The retained earnings account is debited because
the net income of 2018 was overstated. The inventory Required: If the books for 2019 have not been closed,
account is credited because the ending inventory on what is the entry to correct the error on December 31,
December 31, 2018 was overstated. 2019?

• If the books for 2019 have been closed, no entry is Retained earnings 50,000
necessary because the error in 2018 is Purchases 50,000
counterbalanced in 2019. In other words, the ending
inventory in 2018 becomes the beginning inventory in Notes:
2019. Thus, if the beginning inventory of 2019 is 1. The retained earnings account is debited because
overstated, cost of goods sold would be overstated. net income of 2018 was overstated.
2. The purchases account is credited because the
Understatement of Ending Inventory purchase pertains to 2018 and the same is
recorded in 2019, thus resulting to overstatement
• Illustration: On December 31, 2018, the physical count
of 2019 purchases. If the books for 2019 have been
was understated by P50,000.
 closed, no entry is necessary because the 2018 Understatement of Sales
error is counterbalanced in 2019.
Illustration: The entity failed to record sales of P50,000 in
The purchases account in 2018 is understated while the 2018. The same was recoded in 2019. The physical
purchases account in 2019 is overstated. Thus, they inventory was correctly stated on December 31, 2018.
equalize each other.
Required: If the books for 2019 have not been closed,
Overstatement of Purchases & Ending Inventory what is the entry to correct the error on December 31,
2019?
Illustration: The entity recorded on December 31, 2018
P50,000 of purchases in transit to which the entity had no Sales 50,000
title. The same merchandise was included in the Retained earnings 50,000
inventory of December 31, 2018. Notes:
1. The retained earnings account is credited because
Required: If the books for 2019 have not been closed, the 2018 net income was understated. The sales
what are the entries to correct the error on December 31, account is debited because the same pertains to
2019: 2018 and was recorded in 2019, thus overstating 2019
sales.
1. Purchases 50,000 2. If the books for 2019 have been closed, no entry is
Retained earnings 50,000 necessary because the 2018 error is
2. Retained earnings 50,000 counterbalanced in 2019. The sales account of 2018
Inventory, January 1, 2019 50,000 was understated and the sales account of 2019
overstated. They equalize each other.
Notes: In the first entry, the retained earnings account is
credited because the net income of 2018 was Overstatement of Sales/Understatement of Ending
understated by reason of overstatement of purchases. Inventory
The purchases account is debited because the purchase
pertains to 2019 and erroneously recorded in 2018. In the Illustration: The entity recorded on December 31, 2018
second entry, the retained earnings account is debited P50,000 of sales in transit and to which the customer had
and the inventory account is credited because the no title. The cost of the merchandise was P30,000 and the
ending inventory of 2018 was overstated resulting to same was excluded from December 31, 2018 inventory.
overstatement of net income. Required: If the books have not been closed, what are the
entries to correct the error on December 31, 2019?
1. Retained earnings 50,000
Sales 50,000
2. Inventory, January 1, 2019 30,000
Retained earnings 30,000
Notes: In the first entry, the retained earnings account is Failure to record accrued expenses
debited because the 2018 net income was debited. The
sales account is credited because the sale pertains to Illustration: On December 31, 2018, accrued rent expense
2019 and was erroneously recorded in 2018. In the second of P50,000 was not recorded.
entry, the inventory account is debited and the retained
earnings account is credited because the 2018 net Required: If the books for 2019 have not been closed,
income was understated by reason of understatement of what is the entry to correct the error on December 31,
2018 inventory. The inventory account (January 1, 2019) is 2019?
debited because the 2018 ending inventory is
understated. Entry that should be made (not recorded):

Failure to record prepaid expenses Rent expense 50,000

Accrued rent 50,000
Illustration: On January 1, 2018, the entity purchased an
insurance for two years for P50,000. The payment was Correcting entry on December 31, 2019:
debited to an expense and no adjustment was made on
December 31, 2018 for the prepaid insurance. Retained earnings 50,000
Rent expense 50,000
Required: If the books for 2019 have not been closed,
what is the entry the entry to correct the error on Notes: The retained earnings account is debited
December 31, 2019? because the net income of 2018 was overstated. The
rent expense is credited because the accrual of 2018
Entry made on January 1, 2018: necessarily was paid in 2019 and the same was debited
to rent expense, thus overstating the rent expense of
Insurance expense 50,000 2019. If the books of 2019 have been closed, no entry is
Cash 50,000 necessary because the 2018 error is counter balanced
in 2019.
Entry that should be made on Dec. 31, 2018 (not
recorded):
Prepaid insurance (50,000 / 2) 25,000 Failure to record deferred income
Insurance expense 25,000
Illustration: On January 1, 2018, the entity received rent
Correcting entry in 2019: for two years in the amount of P50,000. The same was
Insurance expense 25,000 credited to rent income and no adjustment was made on
Retained earnings 25,000 December 31, 2018.
Required: If the books for 2019 have not been closed, Notes: The retained earnings account is credited
what is the entry to correct the error on December 31, because the 2018 income was understated. The interest
2019? income was debited because the interest accrual of 2018
Entry made on January 1, 2018: necessarily was received in 2019 and the same was
Cash 50,000 credited to interest income, thus overstating the 2019
Rent income 50,000 interest income.

Entry that should be made on Dec. 31, 2018 (not Non-counterbalancing Errors
recorded):
Rent income (50,000 / 2) 25,000 Non-counter balancing errors are errors which if not
Unearned rent 25,000 detected, are not automatically counter balanced or
detected in the next accounting period. In other words, if
Correcting entry on December 31, 2019: the net income of one year is understated or overstated,
Retained earnings 25,000 the net income of subsequent year in not affected.
Rent income 25,000
Effects of non-counter balancing errors:
Notes: The retained earnings account is debited because 1. The income statement of the period in which the
the 2018 net income was overstated. The rent income is error is committed is incorrect but the succeeding
credited because the unearned income because the income statement is not affected.
unearned income on December 31, 2018 becomes an 2. The statement of financial position of the year of error
income of 2019. and succeeding statement of financial position are
incorrect until the error is corrected.
Failure to Record Income
The best example of a no n-counter balancing error is the
Illustration: On January 1, 2018, accrued interest misstatement of depreciation.
receivable of P50,000 was not recorded.
Misstatement of Depreciation
Required: If the books for 2019 have not been closed,
what is the entry to record the error on December 31, Illustration: On January 1, 2018, the entity purchased an
2019? equipment with useful life of 5 years for P500,000 but the
Entry that should be made ( not recorded): same was debited to repair and maintenance.
Accrued interest receivable 50,000
Interest income 50,000 Required:
Correct entry on December 31, 2019: 1. If the books in 2019 have not been closed, what
Interest income 50,000 are the entries to correct the error on December 31,
Retained earnings 50,000 2019?
 2. If the books for 2019 have been closed, what are
the entries to correct the error on December 31,
2019?

Wrong entry made on January 1, 2018:

Repairs and maintenance 500,000
Cash 500,000

Entry that should be made on January 1, 2018:

Equipment 500,000
Cash 500,000

Entry that should be made on Dec 31, 2018 to

record the depreciation:
Depreciation (500,000 / 5) 100,000
Accumulated Depreciation 100,000

1. Correcting entries that should be made on December

31, 2019 if the books in 2019 have not been closed:

a. Equipment 500,000
Retained earnings 500,000

b. Depreciation (500,000 / 5) 100,000

Retained earnings 100,000
Accumulated depreciation 200,000

2. Correcting entries that should be made on December

31, 2019 if the books for 2019 have been closed:

a. Equipment 500,000
Retained earnings 500,000

b. Retained earnings 200,000

Accumulated depreciation 200,000