Prior period error
/What is a Prior Period Error?
A prior period error is an omission from, or a misstatement of, prior-period financial statements. Such an error must have been caused by the failure to use, or the misuse of, information that was available when the financial statements were authorized for issuance and that could be expected to have been obtained.
When you spot a prior period error, the usual approach to correcting it is to do so in the next set of financial statements to be released. Within those statements, you should restate the comparative amounts for the applicable prior period. This could result in changes to the income statement, balance sheet, and/or the statement of cash flows. The result should be comparative amounts that show the financial statements as they should have been as if no error had arisen.
Examples of Prior Period Errors
Here are several examples of prior period errors:
Misclassification of expenses. Recording a capital expenditure as an operating expense or vice versa. For example, a company expenses the purchase of machinery instead of capitalizing and depreciating it over its useful life.
Revenue recognition errors. Recognizing revenue in the wrong accounting period. For example, recording revenue for a service before it is delivered, violating the revenue recognition principle.
Omitted accrued expenses. Failing to accrue for expenses incurred but not yet paid at the period-end. For example, not recording interest expense on a loan for the prior year.
Inventory valuation errors. Misstating inventory due to errors in counting, pricing, or applying the cost-flow assumption (FIFO, LIFO, etc.). For example, overstating ending inventory, leading to an understated cost of goods sold (COGS) and overstated net income.
Depreciation errors. Incorrectly calculating depreciation due to an error in the estimated useful life, salvage value, or depreciation method. For example, forgetting to record depreciation expense for an asset in a prior year.
Failure to recognize liabilities. Omitting liabilities that should have been recognized in prior periods. For example, not recording a warranty liability or a lawsuit settlement that was probable and estimable in the prior period.
Tax reporting errors. Misstating income tax provisions or deferred tax balances. For example, forgetting to record a deferred tax liability for temporary differences in taxable income.
Misapplication of accounting policies. Applying accounting standards inconsistently or incorrectly. For example, incorrectly treating leases as operating leases instead of finance leases under IFRS 16 or ASC 842.
Omitted transactions. Failing to record a transaction altogether. For example, a sales invoice or expense receipt is overlooked and not recorded in the books.
Overstatement of allowances. Incorrectly estimating bad debt provisions or other allowances. For example, overestimating the allowance for doubtful accounts, leading to understated net income in prior periods.
Incorrect capitalization of costs. Capitalizing costs that should have been expensed. For example, capitalizing repairs and maintenance expenses as an asset.
Omitted contingent liabilities. Failing to disclose or recognize contingent liabilities that were probable and could be estimated. For example, not recording a probable legal settlement in prior period accounts.