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Lesson details
- Estimated study time
- 145 min
Learning objectives (6)
The draft error sheet has one row: “Prior-period error, $80,000.” It does not say where the error began, whether it reversed, which balances remain wrong, or what the current entry would do to income. Replace the total with a rollforward.
Use one sign convention
In this lesson, a positive income effect means reported pretax income is overstated. A positive balance effect means the reported account is overstated. State another convention if preferred, but do not change it by account.
Counterbalancing inventory error
Year 1 ending inventory is overstated by $50,000. Assume the next ending inventory is correct and ignore tax initially.
| Effect | Year 1 | Year 2 | Two-year total |
|---|---|---|---|
| Inventory balance overstatement | $50,000 | $0 | — |
| COGS understatement/(overstatement) | (50,000) | $50,000 | $0 |
| Pretax income overstatement/(understatement) | $50,000 | ($50,000) | $0 |
The zero does not make either year correct. Year 1 assets, income, equity, tax, and EPS are overstated. Year 2 income and trend are understated. Compensation, covenants, and decisions may have relied on either period.
Noncounterbalancing capitalization error
Year 1 improperly capitalizes $120,000 that should have been expensed in full, so the correct treatment carries no asset and no later depreciation. The recorded books then recognize $30,000 annual depreciation in Years 2 and 3.
| Layer | Year 1 | Year 2 | Year 3 | Ending after Year 3 |
|---|---|---|---|---|
| Original pretax income overstatement | $120,000 | — | — | — |
| Later depreciation understatement of income | — | ($30,000) | ($30,000) | — |
| Asset overstatement | $120,000 | $90,000 | $60,000 | $60,000 |
The error is partially consumed, not self-corrected. The current ledger still needs a $60,000 asset reduction under the supplied facts; the comparative income effects preserve their original periods.
Derive the entry from balances
For each current account:
supported corrected balance - recorded balance = signed entry adjustment
Then assemble debits and credits using one ledger sign convention and prove that the entry moves each account to the corrected balance. Test whether any part already reversed or was corrected, whether tax follows, and whether prior- period effects are being routed incorrectly through current income.
A current entry does not perform the restatement. It repairs the ledger at the booking date. The comparative statement bridge, opening equity, note, EPS, audit and filing response, and control evaluation remain separate deliverables.
Extend the error map
Trace beyond the obvious accounts:
- balance sheet and classification;
- income and comprehensive income;
- cash-flow classification and indirect reconciliation;
- statement of changes in equity;
- current and deferred tax;
- basic and diluted EPS;
- note tables and policies;
- ratios, trends, covenants, and compensation;
- audit, filing, legal, and internal-control handoffs; and
- the process change that prevents recurrence.
An error schedule is complete when origin, each later recorded consequence, ending accumulated balance, current correction, comparative effects, and every affected projection reconcile without assuming an unsupported reversal.