01 - Correction of Errors

La Verdad Christian College
Applied Auditing
Correction of Errors
Learning Objectives:
After studying this topic, you should be able to:
1. Define error
2. Enumerate and describe the different types of errors.
3. Identify the effects of errors in the accounts presented in the financial statements
4. Prepare adjusting journal entries to correct errors.
Errors
According to PAS 240, “error refers to an unintentional misstatement in financial

statements including the omission of an amount or a disclosure, including:
1. A mistake in gathering or processing data from which financial statements are

prepared;
2. An incorrect accounting estimate arising from oversight or misinterpretation of facts;
3. A mistake in the application of accounting principles relating to measurement,
recognition, classification, presentation or disclosure.”
Fraud
Fraud refers to the intentional act by one or more individuals among management, those
charged with governance, employees, or third parties involving the use of deception to
obtain an unjust or illegal advantage.
Prior Period Errors
Prior Period Errors are omissions form, and misstatements in, the entity’s financial
statements for one or more prior periods arising from a failure to use or misuse of reliable
information that:
a. Was available when financial statements for those periods were authorized for issue;
and
b. Could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.
Such errors include the effects of mathematical mistakes, mistakes in applying accounting
policies, oversights or misinterpretations of facts, and fraud.
Accounting Treatment of Prior Period Error
According to PAS 8 par 42, “ an entity shall correct material prior period errors
retrospectively in the first set of financial statements authorized for issue after their
discovery by:
a. Restating the comparative amounts for the prior periods (s) presented in which the
error occurred; or
b. If the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.
Limitations on retrospective restatement
A prior period error shall be corrected by retrospective restatement except to the extent
that it is impracticable to determine either the period specific effects or the cumulative
effect of the error.
When it is impracticable to determine the period-specific effects of an error on comparative

information for one or more prior periods presented, the entity shall restate the opening
balances of assets, liabilities and equity for the earliest period for which retrospective
restatement is practicable (which may be the current period).
When 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 date practicable.
_________________________________________________________________________
Basic Concepts in Correction of Errors
Errors affecting net Effect in the Net Income Relationship

income:
If Sales are overstated Overstated Direct
If Cost of Sales is Understated Inverse
overstated
If Expenses are overstated Understated Inverse
Errors affecting cost of Effect in Cost of Sales Relationship

sales
If Beginning inventories are Overstated Direct
overstated
If Net purchases are Overstated Direct
overstated
If Ending inventories are Understated Inverse
overstated
Working Capital
Working capital is the capital of a business that is used in its day-to-day trading operations,
computed as the current assets minus the current liabilities.
Errors affecting working- Effect in Working capital Relationship

capital
If the current assets are Overstated Direct
overstated
If the current liabilities are Understated Inverse
overstated
Types of Errors
1. Balance sheet or statement of financial position errors

2. Income statement errors
3. Combined statement of financial position and income statement errors
a. Counterbalancing errors
b. Non-counterbalancing errors
Counterbalancing errors
Counterbalancing errors are errors that will offset or be corrected over two accounting
periods. Examples include the following:
A. Omissions of the following:

1. Deferred expenses (or Prepayments under the expense method).
2. Deferred income (Precollection under the revenue method)
3. Accrued expense
4. Accrued revenues
B. Overstatement or Understatement of the following:
5. Sales not recorded in the first year and subsequently recorded the following year (or
vice versa)
6. Purchases not recorded in the first year and subsequently recorded the following
year (or vice versa)
7. Error affecting ending inventory.
Non-counterbalancing errors
Non counterbalancing errors do not offset in the next accounting period. Therefore
companies must make correcting entries, even if they have closed the books.
Examples
1. Prepayment under the asset method.

2. Precollection under the liability method
3. Error in recording depreciation
4. Improper capitalization of expense
5. Improper expensing of capital expenditures
6. Error in recording of proceeds of sale of an asset (e.g. PPE) as other income.
Correction of Errors
Exercises
Problem 1- Income Statement and SFP Errors
You discovered the following error in connection with your examination of the financial
statements of the Kadenang Tanso Corporation:
1. Rent income of P 25,000 in 2017 was erroneously credited to miscellaneous

income
2. Accounts payable of P 28,000 in 2017 was erroneously credited to notes payable.
The following data were extracted from the financial statements of Kadenang Tanso
Corporation:
2017 2018
Net Income 200,000 160,000
Working capital 180,000 260,000
RE, end of the year 200,000 360,000
Questions:
Based o the above data, determine the following:
1. Net income in 2017

2. Working capital, end of 2017
3. Retained earnings, end of 2017
4. Net Income in 2018
7. Prepare adjusting entries assuming errors were discovered in (a) 2017, (b) 2018,
and (c) 2019.
Problem 2 Counterbalancing Errors

You discovered the following errors in connection with your examination of the financial
statements of the HOC Corporation:
1. Accrued interest expense of P 15,000 was not recorded at end of 2017.
2. Accrued rent receivable of P 20,000 was not recorded at the end of 2017.
3. The company paid one-year insurance premium of P 36,000 effective March 1, 2017.
The entire amount was debited to expense account and no adjustment was made at
the end of 2017.
4. The company leased a portion of its building for P 30,000. The term of the lease is
one year ending April 1, 2018. Collection of rent was credited to rent revenue
account. At the end of 2017, no entry was made to take up the unearned portion of
the amount collected.
The following data were extracted from the financial statements of USANA Corporation:
2017 2018
Net Income 200,000 160,000
Questions:
Based on the above data, determine the following:

and (c) 2019.
Problem 3 Counterbalancing Errors
statements of the Dylan Corporation:
1. Purchase of merchandise on account on December 24, 2017 amounting to P 60,000
was not recorded until it was paid in January 2018. The merchandise was properly
included in the ending inventory in 2017.
2. Sale of merchandise on account on December 30, 2017 amounting to P 80,000 was
not recorded until it was collected in January 2018. The merchandise was properly
excluded in the ending inventory in 2017.
3. On December 31, 2017, the ending inventory was overstated by P 20,000.
The following data were extracted from the financial statements of Dylan Corporation:
2017 2018
Net income 200,000 160,000
Questions:

7. Prepare adjusting entries assuming errors were discovered in (a) 2017, (b) 2018
and (c) 2019.
Problem 4 – Noncounterbalancing Errors
statements of Makino Corporation:
1. The Company paid one year insurance premium of P 36,000 effective March 1, 2017.
The entire amount was debited to asset account and no adjustment was made at the
end of 2017.
2. The company leased a portion of its building for P 30,000. The term of the lease is
one year ending April 30,2018. Collection of rent was credited to unearned rent
revenue account. At the end of 2017, no entry was made to take up the unearned
portion of the amount collected.
3. Depreciation expense in 2017 was overstated by P 12,000.
4. Improvements on building amounting to P 200,000 had been charged to expense on
January 1, 2017. Improvements have a life of 4 years.
5. On January 1, 2017, an equipment costing P 60,000 was sold for P 20,000. At the
date of sale, the equipment had an accumulated depreciation of P 48,000. The cash
received was recorded as other income in 2017.
6. Repairs expense on the building amounting to P 20,000 had been charged to
recorded in 2017 to 2018 based on the 4 year remaining useful life of the building.
The following data were extracted from the financial statements of the Makino Corporation:
2017 2018
Net income 200,000 160,000
Questions:

and (c) 2019.

01 - Correction of Errors

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La Verdad Christian College

After studying this topic, you should be able to:

According to PAS 240, “error refers to an unintentional misstatement in financial

1. A mistake in gathering or processing data from which financial statements are

Prior Period Errors

Accounting Treatment of Prior Period Error

Limitations on retrospective restatement

When it is impracticable to determine the period-specific effects of an error on comparative

Errors affecting net Effect in the Net Income Relationship

Errors affecting cost of Effect in Cost of Sales Relationship

Errors affecting working- Effect in Working capital Relationship

1. Balance sheet or statement of financial position errors

A. Omissions of the following:

1. Prepayment under the asset method.

Problem 1- Income Statement and SFP Errors

1. Rent income of P 25,000 in 2017 was erroneously credited to miscellaneous

Based o the above data, determine the following:

1. Net income in 2017

Problem 2 Counterbalancing Errors

Based on the above data, determine the following:

1. Net income in 2017

Problem 3 Counterbalancing Errors

Based on the above data, determine the following:

1. Net income in 2017

Problem 4 – Noncounterbalancing Errors

Based on the above data, determine the following:

1. Net income in 2017

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