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    Controller Library Value Pack
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    Accounting Standards Library
    Monday
    Mar282011

    What is a prior period adjustment?

    A prior period adjustment can be one of the following two items:

    • The correction of an error in the financial statements that were reported for a prior period; or
    • Adjustments caused by the realization of the income tax benefits arising from the operating losses of purchased subsidiaries before they were acquired.

    Since the second situation is both highly specific and rare, a prior period adjustment really applies to just the first item - the correction of an error in the financial statements of a prior period. An error in a financial statement may be caused by:

    • Mathematical mistakes;
    • Mistakes in the application of GAAP or some other accounting framework; or
    • The oversight or misuse of facts that existed at the time the financial statements were prepared.

    You should account for a prior period adjustment by restating the prior period financial statements. You do so by adjusting the carrying amounts of any impacted assets or liabilities as of the first accounting period presented, with an offset to the beginning retained earnings balance in that same accounting period.

    If you are presenting the results of a prior period alongside the results of the most recent accounting period, and the prior period adjustment impacts the prior period being presented, you must present the results of the prior period as though the error had never occurred.

    If you are making a prior period adjustment to an interim period of the current accounting year, restate the interim period to reflect the impact of the adjustment.

    Finally, when you record a prior period adjustment, disclose the effect of the correction on each financial statement line item and any affected per-share amounts, as well as the cumulative effect on the change in retained earnings.

    Investors and creditors tend to view prior period adjustments with deep suspicion, assuming that there was a failure in a company's system of accounting that caused the problem. Consequently, it is best to avoid these adjustments when the amount of the prospective change is immaterial to the results and financial position shown in the company's financial statements.

    Prior Period Adjustment Example

    The controller of ABC International makes a mistake when calculating depreciation in the preceding year, resulting in depreciation that is $1,000 too low. He finds the error in the following year, and corrects the error with this entry to the beginning balance of retained earnings:

      Debit Credit

    Retained earnings

    1,000  

         Accumulated depreciation

      1,000


    These changes result in the disclosure of the following alteration of ABC's beginning retained earnings balance:

    Retained earnings, January 1, 20X1 150,000
    Prior period adjustment:  
         Correction of depreciation error (1,000)
    Adjusted retained earnings, January 1, 20X1 149,000


    Related Topics

    Change in accounting estimate
    Change in accounting principle
    How do I report an error correction?
    When is an accounting error material? 

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    Reader Comments (6)

    How do you account for these adjustments on the Cash Flow Statement when accounts on it are impacted by the adjustment? For example, a current asset is credited and Retained Earnings is debited.
    The current asset is included in net changes to non-cash related accounts in the operating activities section.

    Thank you.

    December 1, 2011 | Unregistered CommenterSteff

    Hi sir, i would like to ask what adjusting entries i should make regarding the Petty cash fund entries made last year(2011)?

    Our accountant did it wrong by debiting Petty cash account every time there is a replenishment, it resulted over stating the Petty cash fund and understating the expenses.

    I'm lost on how entries will be, the 2011 books are now closed.

    i hope you can help me, thank you very much.

    January 25, 2012 | Unregistered CommenterRaymond

    Petty cash is an immaterial item, so do not go to the effort of modifying it in the prior year. Just adjust it in the current year.

    February 4, 2012 | Unregistered CommenterSteve Bragg

    Hello,

    Question regarding Depreciation.I have received one request to capitalize an invoice with Date placed in service " 11-Mar-2011",Cost 24000/-, and life 3 years. Here I got a question like shall we calculate prior period (From Mar 11 to Dec 11) depreciation? but we have already been closed 2011 books and moved profit/loss to retained earnings. If we book prior year deprection in the current year we may get loss on P&L statement.

    Could you please let me know accouting treatment (Entries) and tax benefits. Grateful if you could provide me with examples.

    Thank you
    Lakshmipathi

    March 13, 2012 | Unregistered CommenterLakshmipathi

    I would not get to accounting entries just yet! You have to make a decision about whether to re-open the prior year's books and drop this item into it. I almost always advise against it, but the size of the change will apparently have a material impact on your financial statements. So... the first step is to discuss this with your auditors. If you can avoid doing so, then drop all of the depreciation that should have been recognized last year into the current period, and then proceed normally with the recognition of all remaining depreciation.

    March 13, 2012 | Registered CommenterSteven Bragg

    Hello

    what prior period errors journal entries will be affected for under stated creditors?

    thanks

    March 19, 2012 | Unregistered CommenterLionel
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