Counterbalancing error

An understated ending inventory overstates cost of goods sold and understates income in the origin year. The same amount enters next year's beginning inventory, understating next year's cost of goods sold and overstating income if the next ending inventory is correct. Across two years the pretax income effects sum to zero; neither year's income was right.

This reversal separates the pattern from a noncounterbalancing error, whose effect does not reverse automatically through later accounting. The labels describe how an error moves across periods. They do not decide whether the error is material or how the entity must correct issued statements.

The schedule carries three views: each period's originating or reversing income effect, each reporting date's accumulated balance-sheet error, and the entry needed when discovered. Tax, EPS, trends, compensation, covenants, and disclosures can remain consequential even after pretax income counterbalances.

Reversal does not cure presentation

ASC 250-10-45-23 requires correction of an error in previously issued statements. It does not create an exception merely because the error reverses later.

Suppose Year 1 ending inventory is understated by $40,000 and Year 2 ending inventory is correct. Year 1 pretax income is understated by $40,000; Year 2 pretax income is overstated by $40,000 through beginning inventory. The two-year total is zero, yet both annual results and their margins are wrong. Evaluate each issued period, the discovery-date balances, and all related disclosures.