Correction of Accounting Errors

BALANCE SHEET ERRORS

These include classification errors among the real accounts in the balance sheet. They have no
effect on the income statement and therefore do not require any restatement of retained earnings.
When comparative financial statements are prepared the classification errors of prior periods
should be corrected for each year presented.

INCOME STATEMENT ERRORS

These include classification errors among the nominal accounts in the income statement. They
have not effect on net income and therefore do not require any restatement of retained earnings.
When comparative financial statements are prepared the classification errors of prior periods
should be corrected for each year presented.

BALANCE SHEET AND INCOME STATEMENT EFFECTS

There are two types of errors involving both the income statement and the balance sheet.
Counterbalancing errors will be offset over two accounting periods. Noncounterbalancing errors
take more than two periods to offset.

A. Counterbalancing Errors
We first need to determine if the books are closed for the current year.
(1) If the books are closed for the current year:
a) No entry is necessary if the error has already counterbalanced.
b) An entry must be made to retained earnings if the error has not counterbalanced.
(2) If the books are not closed for the current year:
a) If the company is in the second year and the error has already counterbalanced, an
entry is necessary to correct the current period and adjusted beginning retained
earnings.
b) If the error has not counterbalanced, an entry is necessary to adjusted beginning
retained earnings and correct the current period.
Restatement of the financial statements is necessary under all conditions.

Example: Spencer Company forgot to accrue payroll at the end of 2001. The amount of
accrued payroll at December 31, 2001 was $25,000. Assuming that the books for 2002 have
NOT been closed the correcting journal entry would be as follows:

DATE ACCOUNT DEBIT CREDIT

12/31/02 Retained earnings 25,000
Salary and wages expense 25,000
To correct error at the end of 12/31/01, failure to accrue payroll
If the books have been closed the error has already counterbalanced and no journal entry is
necessary. The comparative financial statements for Spencer Company for the two years
ended December 31, 2001 and 2002 must reflect the correct amounts of payroll.

B. Noncounterbalancing Errors
It makes no difference whether the books are closed or still open, a correcting journal entry is
necessary.

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Correction of Accounting Errors

Example: Spencer Company purchased a machine on January 1, 2000 for $100,000. The
machine had an estimated salvage value of $10,000 and a service live of 9 years. Spencer
Company uses the straight-line method to depreciate all of its assets. The company incorrectly
expensed the equipment as an expense in the year of purchase. The error was discovered in
2002. Assuming that the books for 2002 are still open the following journal entry would be
required to correct this error.

DATE ACCOUNT DEBIT CREDIT

12/31/02 Equipment 100,000
Depreciation expense 10,000
Retained earnings 80,000
Accumulated depreciation 30,000
To correct for error made in 2000 when the equipment was purchased and
expensed

Analysis of error:
Cost of equipment 100,000 100,000
Salvage value 10,000
Depreciable base 90,000
Service life 9
Annual deprecation 10,000
Years to December 31, 2001 2
Accumulated deprecation 20,000 20,000
Book value at December 31, 2001 80,000
Depreciation expense for 2002 10,000
Accumulated deprecation 30,000

If the 2002 books are closed the following journal entry would be made to correct the error made
in 2000.

DATE ACCOUNT DEBIT CREDIT

12/31/02 Equipment 100,000
Retained earnings 70,000
Accumulated depreciation 30,000
To correct for error made in 2000 when the equipment was purchased and
expensed

Again, it is important to note that if comparative financial statements are prepared the correct
amounts for equipment, accumulated depreciation and depreciation expense are to be reported
for each year presented.

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