Prior period adjustments are transactions that relate to an earlier accounting period but that management was unable to determine during the earlier accounting period. These transactions are known as “adjustments to prior periods.”
In accordance with the all-inclusive notion of income, with a few notable exemptions, the net income for the period takes into account all items of profit and loss that were recorded during the period in question.
The majority of these exceptions are to adjustments made in previous periods, and they are taken into account by making an adjustment to the initial balance of retained earnings.
However, there has been a great deal of debate on the factors that determine whether or not an occurrence counts as an adjustment to a former period.
There are just two occurrences that can be deemed prior period adjustments:
The previous period’s financial statements have been updated to reflect the correction of an error.
Adjustments that are necessary as a direct result of the realization of income tax benefits resulting from the pre-acquisition operating loss carryforwards of purchased subsidiaries.
Due to the fact that the realization of tax benefits is a complex subject, we are only going to look at earlier adjustments that are associated with making repairs for errors.
When reviewing the financial statements of a past year, a company may on occasion find that they include a significant inaccuracy. However, major errors are extremely uncommon, particularly when the financial statements of a company are audited by a certified public accounting firm.
When they do occur, and when they are discovered, the manner in which the error is rectified depends on whether the company publishes single-year or comparative financial statements, as well as the year in which the error was made. When they do occur, and when they are discovered, the manner in which the error is fixed depends on the year in which the error was made.
When single-year results are released, the error is rectified by changing the initial balance of retained earnings on the retained earnings statement. This is done on the statement that reports retained earnings.
A Primer On
As an example of accounting for prior period adjustments in a single-year statement, let’s say that the Mondrian Corporation found out during the audit of its 2019 statements that depreciation in 2018 had been overstated by $100,000, ignoring taxes. This information was uncovered during the audit of the 2019 statements.
Due to the serious nature of this oversight, an adjustment to a previous period is essential. At the end of the year, the following item is made in the journal to rectify this error:
The following is how the statement of retained earnings for 2019 might look like:
In addition, the adjustment to the prior period is discussed in the footnotes that accompany the financial statement.
When compared financial statements are being presented, a separate method must be followed.
If the error was made in an earlier financial statement that is being provided for comparison purposes, then that statement needs to be changed so that it includes the correction for the error.
As a consequence of this, the net income will be revised, and after the revised net income figure has been incorporated into the statement of retained profits, there will be no need for any additional adjustments.
If the error occurred in a year for which the financial statements are not being published, the remedy is accomplished by applying an adjustment to a preceding period to the retained profits balance of the earliest year for which figures are being presented.