Question

Some inventory errors are said to be self-correcting in that the error has the opposite financial statement effect in the period following the error, thereby correcting the original account balance errors. 

 

Required:

Despite this self-correcting feature, discuss why these errors should not be ignored and describe the steps required to account for the error correction.

Answer 1

Despite the self-correcting feature, errors should not be ignored because -

• If the errors are not discovered in the following year;

• It is discovered in subsequent to the following year;

• The financial statements are restated;

• To correct the previous year figures of cost of goods sold and net income;

• Although no correcting journal entry and adjustment in current year is needed because error has self-corrected.

 

Steps required to accounting for the error correction –

• Financial statements for previous years’ are restated retrospectively;

• A journal entry is made correcting any incorrect account balance;

• If retained earnings requires adjustment for correction, statement of shareholder’s equity is adjusted as prior period adjustment;

• A disclosure note is provided describing the nature and impact of the error and correction on income.

Despite the self-correcting feature, errors should not be ignored because -

• If the errors are not discovered in the following year;