Everyone makes mistakes and accountancy is no exception when it comes to human error.
Unfortunately, some mistakes can be costly to companies as well as embarrassing for those that have made the mistake. FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with the correction of errors in Section 10 Accounting Policies, Estimates and Errors in paragraphs 10.19 to 10.23.
The difference between FRS 102 and UK GAAP
There is a notable difference between FRS 102 and old UK GAAP where error correction is concerned.
Under previous UK GAAP, an error was corrected by way of a prior year adjustment where the error was ‘fundamental’. The term ‘fundamental’ was taken to mean that the error destroyed the true and fair view and the validity of the financial statements.
Under FRS 102, an error is corrected by way of a prior year adjustment if the error is ‘material’. Hence, more errors will be corrected through a prior year adjustment under FRS 102 than was the case under old UK GAAP.
Definition of ‘errors’ in the Glossary to FRS 102
‘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:
(a) Was available when financial statements for those periods were authorised for issue and
(b) Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.’
Financial statements often contain a degree of estimation for certain amounts (for example, a provision for a legal case). Errors and accounting estimates are distinct because accounting estimates will need changing as additional information becomes known, hence such changes are not errors. Errors arise when:
- Information was available, but was either not used or found;
- A calculative error has been made in the financial statements; or
- An item has been misclassified (for example, a fixed asset has been posted to repairs and renewals expenditure).
Accounting for the correction of errors
A material prior period error is corrected by way of a prior period adjustment which involves retrospective restatement.
Paragraph 10.21 of FRS 102 requires an entity to correct a material prior period error retrospectively in the first financial statements authorised for issue after its discovery. The standard is silent on the correction of immaterial errors which is consistent with the fact that accounting standards only deal with material items.
In addition, FRS 102 does not specifically require revised financial statements to be issued once the error has been retrospectively corrected. However, where revised financial statements are issued, they will essentially replace the previous ones issued for that particular financial year.
Paragraph 10.21 of FRS 102 goes on to outline how a material prior period error is corrected as follows:
(a) Restate the comparative amounts for the period(s) presented in which the error occurred; or
(b) If the error occurred before the earliest prior period presented, restate the opening balances of assets, liabilities and equity for the earliest prior period presented.
The accounts senior is preparing the year-end financial statements for Aurora Ltd for the year-ended 31 March 2018. During the course of the accounts preparation, she discovered that last year’s sales were understated by £75,000 with a consequential understated VAT creditor of £15,000 (£75,000 x 20%). The error is material to the financial statements.
Financial statement extracts are as follows:
The journals required to effect the prior year adjustment (which will be posted in the 2017 financial year) are as follows:
Financial statement extracts immediately after the prior year adjustment are as follows:
There will also be consequential corporation tax adjustments which have been ignored for the purposes of this example.
When prior period amounts have been restated, it is good practice to show the comparative year on each page of the financial statements with the heading ‘as restated’ together with a reference to the note explaining the prior period adjustment (even though there is no specific requirement to do this).
Paragraph 10.23 of FRS 102 requires the following to be disclosed about material prior period errors:
(a) The nature of the prior period error;
(b) For each prior period presented, to the extent practicable, the amount of the correction for each financial statement line item affected;
(c) To the extent practicable, the amount of the correction at the start of the earliest prior period presented; and
(d) An explanation if it is impracticable to determine the amounts to be disclosed in (b) or (c).
Keep this in mind
Keep in mind that immaterial errors need not be corrected by way of a prior period adjustment, but material ones will. Determining what is ‘material’ will involve professional judgement but in most cases it will be clear whether an error(s) is/are material.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.