There are a number of different kinds of errors. Some errors are discovered in the period in which they are made and are easily adjusted. Others may not be discovered currently and are incorrectly reflected in the financial statements until discovered. Some errors are never discovered; however, the effects of these errors may be counterbalanced in subsequent periods, and after this takes place, account balances are again accurately stated. Errors may be classified as follows:
- Errors discovered currently in the course of normal accounting procedures. Examples of this type of error are clerical errors, such as an addition error, posting to the wrong account) misstating an account, or omitting an account from the trial balance. These types of errors usually are detected during the regular summarizing process of the accounting cycle and are readily adjusted.
- Errors limited to balance sheet accounts. Examples include debiting accounts receivable instead of notes receivable, crediting interest payable instead of notes payable, or crediting interest payable instead of salaries payable. Another example is not recording the exchange of convertible bonds for stock. Such errors are frequently discovered and adjusted in the period in which they are made. When such errors are not found until a subsequent period, adjustments must be made at that time and balance sheet data subsequently restated for comparative reporting purposes.
- Errors limited to income statement accounts. The examples and correcting procedures for this type of error are similar to those in (2) above. For example, office salaries may be debited instead of sales salaries. This type of error should be adjusted as soon as it is discovered. Even though the error would not affect net income, the misstated accounts should be restated for analysis purposes and comparative reporting.
- Errors affecting both income statement accounts and balance sheet accounts. Certain errors, when not discovered currently, result in the misstatement of net income and thus affect both the income statement accounts and the balance sheet accounts. The balance sheet accounts are carried into the succeeding period; hence, an error made currently and not detected will affect future earnings. Such errors may be classified into two groups:
- Errors in net income that, when not detected, are automatically counterbalanced in the following fiscal period. Net income amounts on the income statements for two successive periods are inaccurately stated; certain account balances on the balance sheet at the end of the first period are inaccurately stated, but the account balances in the balance sheet at the end of the succeeding period will be accurately stated. In this class are errors such as the misstatement of inventories and the omission of adjustments for prepaid and accrued items at the end of the period.
- Errors in net income that, when not detected, are not automatically counterbalanced in the following fiscal period. Account balances on successive balance sheets will be inaccurately stated until such time as entries are made compensating for or correcting the errors. In this class are errors such as the recognition of capital expenditures as expenses and the omission of charges for depreciation and amortization.
When errors affecting income are discovered, careful analysis is necessary to determine the required action to correct the account balances. As indicated, most errors will be caught and adjusted prior to closing the books. The few material errors not detected until subsequent periods and those that have not already been counterbalanced must be treated as prior-period adjustments.
See also Examples of adjustments of errors for many examples and their adjustment to restore the correct accounting of these transactions.