THEORY FINANCIAL ACCOUNTING (2018 EDITION)

CHAPTER 62
ERROR CORRECTION

QUESTION 62-1

What are prior period errors?

ANSWER 62-1

Prior period errors are omission from and misstatements in the entity’s financial statements for one or more periods
arising from a failure to se or misuse of reliable information that:

a. Was available when financial statements for these periods were authorized for issue.
b. Could reasonably expected to have been obtained and taken into account in the preparation and
presentation of those financial statements.

Prior period errors include the effects of mathematical mistakes, mistakes in applying accounting policies,
overnights or misinterpretation of facts, and fraud.

QUESTION 62-2

What are counterbalancing errors?

ANSWER 62-2

Counterbalancing errors are those which if not detected are automatically counterbalanced or corrected in the next
accounting period.

In other words, these errors will be offset or corrected over two periods or these errors correct themselves over two
periods.

If the net income of one year is understated, the net income of subsequent year is overstated.

Counterbalancing errors usually include misstatement of inventory, prepaid expense, accrued expense, deferred
income and accrued income.

QUESTION 62-3

What are noncounterbalancing errors?

ANSWER 62-3

Noncounterbalancing errors are those which 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 subsequent year is not
affected.

Noncounterbalancing errors usually include misstatement of depreciation and doubtful accounts.

QUESTION 62-4

Explain the treatment of prior period errors.

ANSWER 62-4

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 period presented in which the error occurred.
b. Restating the opening balanced of assets, liabilities and equity for the earliest prior period presented if the
error occurred before the earliest period presented.

In other words, a prior period error shall be corrected by retrospective restatement.

This means that if comparative statements are presented, the prior year statements are restated to correct the error.

The correction of a prior period error is an adjustment of the beginning balance of retained earnings of the earliest
period presented.

QUESTION 62-5

1. If ending inventory is understated, the effect is to

a. Overstate the net purchases
b. Overstate the gross margin
c. Overstate the cost of goods available for sale
d. Overstate the cost of goods sold

2. If beginning inventory is overstated, the effect is to

a. Overstate net purchases
b. Overstate the gross margin
c. Overstate the cost of goods available for sale
d. Overstate the cost of goods sold

3. The overstatement of ending inventory in the current year will cause

a. Retained earnings to be understated in the current year-end statement of financial position.
b. Cost of goods sol to e understated in the income statement of next year.
c. Cost of goods sold to be overstated in the income statement of the current year.
d. Statement of financial position not to be misstated in the next year-end.

4. At the middle of the year, an entity paid for insurance premium for the current year and debited the amount
to prepaid insurance. At year-end, the bookkeeper forgot to record the amount expired. In the financial
statements prepared at year-end, the omission
a. Overstates owners’ equity
b. Understates assets
c. Understates net income
d. Overstates liabilities

5. When the current year’s ending inventory is overstated

a. The current year’s cost of goods sold is overstated.
b. The current year’s total assets are understated.
c. The current year’s net income is overstated.
d. The next year’s net income is overstated.

6. An overstatement of ending inventory in the current period would result in income of the next period being
a. Overstated
 b. Understated
c. Correctly stated
d. The answer cannot be determined from the information

7. Which of the following would result if the current year’s ending inventory is understated in the cost of
goods sold calculation?
a. Cost of goods sold would be overstated
b. Total assets would be overstated
c. Net income would be overstated
d. Retained earnings would be overstated

8. If the beginning inventory in the current year was overstated, and that is the only error in the current year,
the income for the current year would be
a. Understated and assets are correctly stated.
b. Understated and assets are overstated
c. Overstated and assets are overstated
d. Understated and assets are understated
9. Which of the following would cause income to be overstated in the period of occurrence?
a. Overestimating bad debt expense
b. Understating beginning inventory
c. Overstated purchases
d. Understated ending inventory

ANSWER 62-5

1. D 6. B
2. C 7. A
3. D 8. A
4. A 9. B
5. C

QUESTION 62-6

1. Failure to record the expired amount of prepaid rent expense would not
a. Understate expense
b. Overstate net income
c. Overstate owners’ equity
d. Understate liabilities

2. Failure to record accrued salaries at the end of an accounting period results in

a. Overstated retained earnings
b. Overstated assets
c. Overstated liabilities
d. Understated retained earnings

3. Failure to record depreciation expense at the end of an accounting period results in

a. Understated income
b. Understated assets
c. Overstated expenses
d. Overstated assets

4. Which of the following would cause income of the current period to be understated?
a. Capitalizing research and development cost
b. Failure to recognize unearned rent revenue
c. Changing from weighted average to FIFO for merchandise inventory
d. Understating estimate of residual value
 5. Which of the following is a counterbalancing error?
a. Understated depletion expense
b. Bond premium under-amortized
c. Prepaid expense adjusted incorrectly
d. Overstated depreciation expense

6. Which of the following errors will not self-correct in the next year?
a. Accrued expense not recognized at year-end
b. Accrued revenue not recognized at year-end
c. Depreciation expense overstated for the year
d. Prepaid expense not recognized at year-end

7. Which of the following, if discovered in the accounting period subsequent to the period of occurrence,
should be reported as correction of an error?
a. The estimate of useful life od a depreciable asset should have been revised
b. A change from double declining to straight line depreciation
c. Capitalization of an expense
d. Change in percentage of sales used for determining bad debt expense

8. An entity used a periodic inventory system and neglected to record a purchase of merchandise on account
at year-end. This merchandise was omitted form the year-end physical count.

How will these errors affect assets, liabilities and shareholders’ equity at year-end and net earnings for the
year?
Assets Liabilities Equity Net earnings

a. Understate Understate No Effect No Effect

b. Understate No Effect Understate Understate
c. No Effect Understate Overstate Overstate
d. No Effect Overstate Understate Understate

ANSWER 62-6

1. D 5. C
2. A 6. C
3. D 7. C
4. D 8. A

QUESTION 62-7

1. At year-end, an entity ordered merchandise for resale. The merchandise was shipped F.O.B. shipping point
at year-end and the goods arrived early next year. The entity did not record the purchase in the current year
and did not include the goods in ending inventory. The effects on the financial statements for the current
year were
a. Income and owners’ equity were correct, liabilities were incorrect, assets were correct
b. Income and owners’ equity were correct, assets and liabilities were incorrect
c. Income, assets, liabilities and owners’ equity were correct
d. Income, assets, liabilities and owners’ equity were incorrect

2. If at end of period an entity erroneously excluded some goods from the ending inventory and also
erroneously did not record the purchase of these goods in the accounting records, these errors would cause
a. The ending inventory, cost of goods available for sale and retained earnings to be understated
b. The ending inventory, cost of goods sold and retained earnings to be understated
c. No effect on net income, working capital and retained earnings
d. Cost of goods available for sale, cost of goods sold and net income to be understated
 3. Which of the following should not be reported retroactively?
a. Use of an unacceptable accounting principle and then changing to an acceptable accounting
principle.
b. Correction of an overstatement of ending inventory made in prior year
c. Use of an unrealistic accounting estimate and then changing to a realistic estimate
d. Change from a good faith but erroneous estimate to a new estimate

4. At the end of the current year, special insurance costs, incurred but unpaid, were not recorded. If these
insurance costs were related to work in process, what is the effect of the omission on accrued liabilities and
retained earnings, respectively in the current year-end statement of financial position?
a. No effect and No effect
b. No effect and Overstated
c. Understated and No effect
d. Understated and Overstated

5. Which of the following errors could result in an overstatement of both current assets and shareholders’
equity?
a. An understatement of accrued sales commissions
b. Noncurrent note receivable principal is misclassified as current asset
c. Annual depreciation on manufacturing machinery is understated
d. Holiday pay expense for administrative employees is misclassified as manufacturing overhead

6. At the end of the current year, an entity failed to accrue sales commissions during the current year but paid
in the next year. The error was not repeated in the next year.

What was the effect of the error on current year-end working capital and retained earnings, respectively?
a. Overstated and Overstated
b. No effect and Overstated
c. No effect and No effect
d. Overstated and No effect

ANSWER 62-7

1. B 4. C
2. C 5. D
3. D 6. A