Correction of an Error in Financial Reports

Definition

The financial accounting term correction of an error in financial reports refers to the rectification of a mistake caused by a transaction that was recorded incorrectly or omitted.  Accounting principles require the retrospective restatement of financial statements that were incorrect.

Explanation

While it certainly strives for perfection, the accounting profession is not infallible.  An accounting change can result from a change in reporting entities, principles and estimates.  As is the case with accounting changes, the correction of an error requires the restatement of the financial statements in those prior periods affected by the error.  These errors can involve both incorrectly recorded transactions as well as transactions that were never recorded.  Examples of such errors include:

• Accounting Principles:  switching from what would be considered an unacceptable accounting principle to a generally accepted accounting principle.
• Accruals / Deferrals:  failure to properly account for an accrual or deferral at the end of an accounting period.
• Computational Errors:  includes addition and subtraction errors that result from both human error as well as mistakes in software programs.
• Estimates:  failure to provide good faith estimates, which is a generally accepted accounting principle.
• Facts:  the misuse of facts and other information used in the preparation of financial statements.
• Misclassifications:  includes misclassifying assets as an expense, or an expense as an asset.

Correction of errors are handled as prior period adjustments, going back to the earliest period the error appeared in a financial statement.  A disclosure in the notes to financial statements describing the error is also required.

Note:  In May 2005, the Financial Accounting Standards Board issued SFAS 154, Accounting Changes and Error Corrections, which replaced APB Opinion 20 and SFAS 3.  This was an attempt to move to a more consistent approach with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, which was revised in December 2003.

Related Terms

change in accounting principal, change in accounting estimates, change in reporting entity, accounting changes