PRIOR YEAR ADJUSTMENT – IFRSs GUIDELINE (1)

Financial statements are required to faithfully represent the transactions and events of a company for a reporting period. This means that financial statements should be complete, neutral and free from error. To achieve this, it is emphasized that management should establish sound accounting and internal control systems to ensure the sanctity of financial reporting. But sometimes, accountants could make mistakes in reporting certain transactions. Such errors include mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.  If such errors are detected in the current period, then fine, it can be corrected. But often times, these errors are not detected until another accounting year. The correction of these errors in another accounting year, therefore, would lead to prior year adjustment. Prior year adjustment is therefore a means of correcting past financial statements that were misstated due to errors.

WHAT IS PRIOR YEAR ADJUSTMENT?

Prior year adjustment is the correction of prior period errors. According to IAS 8 (Accounting policies, changes in accounting estimates, and errors), prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

a.) Was available when financial statements for those periods were authorised for issue; and

b.) Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.

Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of financial statements. Financial statements do not comply with IFRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of an entity’s financial position, financial performance, or cash flows. 

TREATMENT OF PRIOR YEAR ADJUSTMENT PRIOR TO THE REVISED IAS 8

Before the 2003 revised IAS 8, the practice has been to present prior year adjustments in the current year statement of comprehensive income. The previous standard allows a company to include a prior year adjustment in the profit or loss for the current period and to present unchanged comparative information from financial statements of prior periods.

This treatment, I believe, was a lazy option which was abused grossly until the IASB came up with a revised IAS 8.

REQUIREMENTS OF THE REVISED IAS 8

With the revised IAS 8 (Accounting policies, changes in accounting estimates, and errors), the alternative to report a prior year adjustment in the current year profit or loss has been scrapped. To effect a correction of prior year errors, one needs to do a restrospective restatement by:

a.) Restating the comparative amounts for the prior period(s) presented in which the error occurred; or

b.) If the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

CASE EXAMPLE 1:

In 2000, a company posted motor running expenses of #2,000 to motor vehicle account by debiting the motor vehicle account. In 2001, the accountant detected this error and sought to correct it. 

SOLUTION

Firstly, what was the error committed? Motor vehicle account (an asset account) was debited instead of debiting the profit or loss statement. As a result, the cost of motor vehicles has been overstated as well as the accumulated depreciation (since the #2,000 would have been depreciated as well in year 2000)

To correct this, according to the revised IAS 8, we would not correct it in 2001 profit or loss statement rather since we are reporting year 2000 as comparatives, the correction will be in year 2000 to restate the comparative figures as follows:

1.) DR – Retained earnings 

        Cr – Motor vehicle account

2.) Dr – Accumulated depreciation (say the depreciation charge in year 2000 on the amount is #500)

        Cr – Retained earnings

You are still not clear? I will deal extensively with case examples in the next article. Make it a duty to read the next article on prior year adjustment.

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Written by Abayomi Samuel.