Question

Most errors are discovered automatically through proper use of the double-entry system or by the internal or external auditors. However, some errors escape detection until after they have been included in the published financial statements of a company.

Required:
Describe three types of errors that occur in financial statements and indicate the appropriate corrective action to take when the errors are discovered.

Answer 1

According to US GAAP 3 types of errors that occur in financial statements are

1- Error of commision

2- Error of omission

3- Error of principle

Error of commision - It occurs when the accountant passes a wrong entry or posting of an account to a wrong ledger or calculating a wrong amount. It happens due to lack of attention to the work or sometimes even acting intentionally.

Error omission - It occurs when an accountant forgets to enter a certain transaction or to pass a journal entry or if he records only a portion (either debit or credit) of a particular transaction, then these mistakes are called errors of omission. Accountant can also forget to post any journal entry in ledger accounts.

Error of principle - It occurs when an accountant records transactions against the rules and standards of US GAAP principles  then it is called error of principle. For example, accountant takes all capital expenditures as revenue expenditures and passes the entry of machinery purchased in purchase account.

If the errors are immaterial in nature and are not significant no corrective actions will be taken.

But if the errors are material and needs immediate action corrections should take. Those errors that affect the income or loss reporting in prior periods are corrected by adjusting the beginning balance of retained earnings.

If financial statements of prior year are reported on a comparative basis they will be restated to correct amounts. If there is an error in the financial statement which is presented earlier, it will be corrected by adjusting beginning retained earnings including the effects on income tax for the period which the financial statements presented.