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2nd Flr, GF Partners Bldg, 139 H.V. dela Costa, Salcedo Village, Makati City
AUDITING PROBLEMS
Accounting for Changes and Correction of Errors Prof. L.O. Aristorenas
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Definition of Terms
Accounting policies - specific principles, bases, conventions, rules and
practices adopted by an enterprise in preparing and presenting the financial statements.
Fundamental errors - are errors discovered in the current period with
such significance, that the financial statements of one or more prior periods can no
longer be considered to have been reliable at the date of their issue.
Accounting Procedure:
Benchmark treatment
A change in accounting policy/principle should be applied retroactively unless the
amount of any resulting adjustment that relates to prior periods is not reasonably determinable.
Any resulting adjustment should be reported as an adjustment to the opening balance of the
retained earnings. Comparative information should be restated unless it is impracticable to do
so.
Accounting Procedure:
a. Report current and future financial statements on the new basis.
b. Present prior period financial statements as previously reported.
c. Make no adjustment to current period opening balances.
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CORRECTION OF ERRORS
No company whether large or small is immune from errors. Errors may be intentional
or unintentional. Intentional errors are significant because of the presence of fraud or intent to
deceive. These errors are made for the purpose of concealing fraud or misappropriation,
evading taxes, manipulating or window-dressing the company's financial statements.
Unintentional errors were not deliberately committed. They result from carelessness or
ignorance on the part of the company's personnel or it may result from poor internal control.
The risk of material errors may be minimized through the installation of good internal
control and the application of sound accounting procedures. Prior period adjustments, also
called fundamental errors are reported in the current year as adjustment in the beginning
balance of the Retained Earnings account. Prior period statements should be restated to
correct the error when comparative statements are prepared.
Accounting Procedure:
1. If detected in the period the error occurred, correct the accounts through normal
accounting cycle adjustments.
2. If detected in subsequent period, adjust errors by making prior period
adjustments directly to Retained Earnings or restate the beginning balance of the
Retained Earnings account.
3. Correct all previously presented prior period statements.
TYPES OF ERRORS
1. Balance Sheet Errors
This type of error refers to improper classification of real accounts such as assets,
liabilities or stockholders' equity accounts. They have no effect on net income
2. Income Statement Errors
This type of error affects only the presentation of nominal accounts in the Income
Statement. It involves the improper classification of revenues and expenses accounts, hence,
only the details of the Income Statement are misstated. A reclassifying entry is necessary only
if the error is discovered in the same year it is committed. It has no effect on the Balance
sheet and in the Income Statement. If the error is discovered in a subsequent year, no
classification entry is necessary.
3. Combined Balance Sheet and Income Statement errors
This affects both the balance Sheet and the Income Statement because they result
in the misstatement of net income.
Effect: Net Income of two successive periods are misstated. The amount of
misstatement in one period is equal to but opposite in effect in the income of the
next period.
Counterbalancing errors include the misstatements of the following accounts:
1. Inventories to include the following
a. Purchases
b. Sales
2. Prepaid expenses
3. Deferred Income
4. Accrued expense
5. Accrued Income
GUIDELINES
Books are open
1. If the error is already counterbalanced and the company is in the
second year, an entry is necessary to correct the current period and to
adjust the beginning balance of the Retained earnings.
2. If the error is not yet counterbalanced, an entry is necessary to adjust
the beginning balance of the Retained earnings and correct the current
period.
Books are closed
1. If the error is already counterbalanced, no entry is necessary.
2. If the error is not yet counterbalanced, an entry is necessary to adjust
the present balance of the Retained earnings.
END