1 Best Read – An error in issued financial statements

An error in issued financial statements

Adjustment of an error in issued financial statements (i.e. financial statements approved by Board of Directors and by the Shareholders (in general meeting), and filed at a a Chamber of Commerce / Companies House) is fundamentally different from a chance in accounting policies or a change in estimates. See the following definitions from IAS 8:

Error Accounting policies Change in accounting estimate

Prior period errors are omissions from, 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:

  • was available when financial statements for those periods were authorised for issue; and
  • could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors.

Such errors include a broad range of accounting events/transactions, such as:

  • mathematical mistakes (from simple to complex),
  • mistakes in the application of accounting principles,
  • mistakes in judgement by management and/or oversight in the particular circumstances of omission  or misstatement, or
  • misuse of facts and fraud that existed at the time financial statements were prepared.
Something else -   Types of accounting errors

Here is the procedure in accounting for errors explained in an extreme example, in order to obtain a clear understanding:An error in issued financial statements

  1. If an error is detected in the same period the error occurred the transactions concerned are corrected through normal accounting cycle adjustments,
  2. If an error is detected in a subsequent period (i.e. after the financial statements have become final (see intro above), the effect of material errors is adjusted by making prior-period adjustments directly to the retained earnings balance for the years affected by those errors.The following two situations may emerge:
    1. Normally financial statements contain the financial statements for the year ended as at 31 December 20×9, and comparative figures over the year ended as at 31 December 20×8. The error will be adjusted in the periods it arose (so opening balance 1 January 20×8 (part relating to the period prior to 1 January 20×8, error accumulated up to 1 January 20×8) and/or the income statement for the year ended as at 31 December 20×8 (part relating to the year ended as at 31 December 20×8). So if the error relates to a year that is not presented in the financial statements, the retained earnings opening balance for the earliest year presented is adjusted (i.e. the before mentioned error accumulated up to 1 January 20×8). This results into allocation of the accounting profits or losses for the years ended 31 December 20×9 AND 31 December 20×8 on the same basis of accounting,
    2. If the financial statements or the management discussion and analysis section (MD&A) for the year ended as at 31 December 20×9 contain longer overviews (5 years of performance review, 10 years of performance review) an error has to be adjusted in the opening balance of the first year the error occurred, just two theoretical examples to picture the procedure:
      1. if an error was systematically made for over 10 years, the error is adjusted in a 10 years of performance review in year -10 or 20×9-10 in the overview (part relating to the period prior to year -11, error adjustment accumulated up to 1 January 20×9-10) and/or in each year in the overview for the part of the error adjustment for each year. This results into allocation of the accounting profits or losses for the 5 years on the same basis of accounting,, or
      2. if an error was detected in 20×9 and a detailed investigation showed it started in 20×6, the error is adjusted in a 10 years of performance review in year 20×6 in the overview (part relating to the period prior to year 20×6 (if any), error accumulated up to 1 January 20×6) and in each year in the overview from 20×6 to 20×9. This results into allocation of the accounting profits or losses for the 10 years on the same basis of accounting,, and
  3. Once an error is discovered in previously issued financial statements, the nature of the error, its effect on the financial statements, and its effect on the current period’s income (and comparatives) and EPS should be disclosed (see b for comparative figures and 5 years of performance review, 10 years of performance review).

In summary:

An error in issued financial statements

Explanations: An error in issued financial statements

Period – Detected: This is the year in which the error was detectedAn error in issued financial statements

Period – Adjust: the years that needed to be adjusted (because of the very theoretical situation that the same error was made in each year from 20×0 up to (and detected) in 20×9 An error in issued financial statements

01-Jan – Adjust: the accumulated error adjustment (normally the question would be if any, here in extreme the error repeated in each year in the 10 years period) in the opening balance of the first period presented (see above Error accumulation)

Same basis: by adjusting an error accumulation (if any) in the opening balance of the first period presented each period profit or loss is based on the application of a consistent set of accounting policies and a consistent adjustment of the errors in each period, based on a detailed and documented investigation An error in issued financial statements

Something else -   Examples of adjustments of errors

Adjustments of accounting errors An error in issued financial statements

A financial statement error can impact the interpretation of the financial statements in the year of the error and in all subsequent years when the error year is used for comparison. For financial reporting purposes, when an error is detected, all financial statements presented for comparative purposes are adjusted and restated. For bookkeeping purposes, most errors that go undetected counterbalance over a 2-year period; those errors that impact income and that have not counterbalanced are adjusted by making a direct adjustment to retained earnings.

Error adjustment accounting is fundamentally different from accounting for accounting changes, the treatment errors is specified in IAS 8. IAS 8 41 – 53 covers the adjustment of errors made in a previous year. They are treated for accounting purposes as prior-period adjustments. They should be charged or credited net of tax to retained earnings and reported as an adjustment in the statement of shareholders’ equity in theAn error in issued financial statements opening balance of the comparative period included in the financial statements. It is not included in net income for the current period.

If the company uses longer periods of comparative periods errors have to be adjusted back to the first period used in the comparatives (i.e. 5 year comparatives, the error is adjusted back to the oldest year in the opening balances of that oldest year – if and when the error was also recorded in those comparative periods). An error in issued financial statements

Prior-period adjustments adjust the beginning balance of retained earnings for the net of tax effect of the error as follows (FS 2019 from above):

Reporting period 20×9 Comparatives 20×8
Retained earnings—1/1 100,081 Retained earnings—1/1 1 100,500
Prior-period adjustments (net of tax) (1,175)
Retained earnings—1/1 adjusted 99,325
Add: net income 2,579 Add: net income 2,756
Less: dividends (1,900) Less: dividends (2,000)
Retained earnings—12/31 100,760 Retained earnings—12/31 100,081

Errors may arise because of mathematical mistakes, erroneous application of IFRS, or misuse of information existing at the time the financial statements were prepared. Additionally, changing a principle that is not IFRS to one that is IFRS represents an error adjustment.

In ascertaining whether an error is material and therefore reportable, consideration should be given to the significance of each adjustment on an individual basis and to the aggregate effect of all adjustments.

An error must be adjusted immediately when uncovered.

If comparative financial statements are presented, there should be a retroactive adjustment for the error as it impacts previous years. The retroactive adjustment is presented via disclosure of the impact of the adjustment on prior years’ earnings opening balance and components of net income. An error in issued financial statements

Footnote disclosure for error adjustments in the year found include the nature and description of the error, financial effect on income before extraordinary items, net income, and related earnings per share amounts.An An error in issued financial statements

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