Prior period adjustments

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Nobody is destined to never make a mistake, and unfortunately every now and then, a company (and yes accountants, too) fall into that group as well. Even though CFOs, accountants and auditors do everything they can to avoid them, mistakes happen and steps have to be taken once found to correct those prior period errors. The Financial Accounting Standards Board (FASB) realizes that mistakes may and will transpire, so fortunately, they have put rules and guidelines in place to help correct and adjust those prior mistakes.

Correction of an error happens retrospectively. While in life we like to move forward from our mistakes, in accounting, we are required to go back and right our wrongs. Whether it is a simple math error or a mistake in accounting principle application, a prior period adjustment (or restatement) for all previously issued financial statements is required under FASB Codification Topic 250 to account for the material error. When presenting comparative financial statements, the adjustment is made to each prior period affected line item. When presenting single year financial statements, opening retained earnings will be restated.

Prior period adjustments are capable of affecting the balance sheet, income statement or even both. If the error affects both, opening retained earnings will be affected and prior period adjustment entry will need to be recorded.

For example, let’s say a company failed to accrue payroll at the end of 2016 for $25,000, which is considered to be a material amount. The following adjusting journal entry must be booked in 2017 to account for the error.

prior period adjustments, audit, accounting, FASB

For issued financial statements, the footnotes must disclose that the previously issued financial statements have been restated, along with a description of the error. Additional required disclosures are as follows:

  • The effect of the correction on each financial statement line item affected for each prior period presented.
  • The cumulative effect of the change on retained earnings (or other appropriate components of equity) as of the beginning of the earliest period presented
  • For single period financial statements, the effects of a prior-period adjustment (gross and net of tax) on beginning retained earnings and net income of the preceding period
  • For comparative financial statements, the effects of a prior-period adjustment (gross and net of tax) on net income for each period presented
  • The amount of income tax applicable to each prior-period adjustment

Even though accountants are not thrilled to come across mistakes, prior period adjustments (restatements) are necessary to account for the human error. Aside from a deliberate mistake or fraud, a prior period adjustment shows that understanding and compassion is possible.

CJ McGrady