Prior Period Adjustment
While there are many metrics where accounting involves approximation, prior period adjustments are modifications made to prior periods that are not current periods but have already been accounted for. To ensure that the other criteria are upheld, they must frequently be updated because approximation may not always be an exact quantity.
Prior period adjustments can arise due to a variety of reasons, including errors, changes in accounting principles, changes in estimates, or corrections of prior period misstatements. Companies must carefully evaluate the need for prior period adjustments and ensure that the adjustments are correctly recorded and disclosed in their financial statements.
There are different types of prior period adjustments, including:
- Error corrections: These are adjustments made due to an error in the previous period's financial statements. For example, if a company made a mistake in calculating its depreciation expense, it could make an error correction to fix the mistake and adjust the financial statements of the previous period.
- Changes in accounting principles: Sometimes, companies change their accounting principles due to new accounting standards or regulations. In such cases, prior period adjustments are necessary to reflect the impact of these changes on the financial statements of the previous period.
- Changes in estimates: Companies use estimates to account for uncertain events, such as bad debts, inventory obsolescence, or warranties. If these estimates change in subsequent periods, prior period adjustments may be required to reflect the impact on the financial statements of the previous period.
- Corrections of prior period misstatements: Misstatements can occur due to fraud, error, or omission. These misstatements can be intentional or unintentional. If discovered, prior period adjustments may be necessary to correct the misstatements and adjust the financial statements of the previous period.
When you restate financial statements from the previous period, it's important to make a prior period adjustment. This involves adjusting the beginning balance of retained earnings in the first period presented, by offsetting it with an adjustment to the carrying values of any affected assets or liabilities.
The following factors may contribute to financial statement preparation errors:
- Mistakes in mathematics
- Errors in the application of accounting principles
- Incorrect analysis of the facts and data
- Omitting or delaying the recording of some costs or income
- When financial statements were made, fraud or factual misstatement was present.
- Creating a Presentation for Prior Period Adjustment
When a prior period adjustment affects the prior period being presented and you are presenting the results of the prior period alongside the results of the most current accounting period, you must present the prior period results as if the error never happened. Restate the interim period to reflect the impact of the adjustment if you are applying a prior period adjustment to an intermediate period of the current accounting year.
Last but not least, when you record a prior period adjustment, you must identify the correction's impact on every line item on the financial statement, any affected per-share amounts, as well as the total impact on the change in retained earnings.
In the first set of financial statements cleared for release following their discovery, a business must retrospectively correct significant prior period adjustments or errors in one of the following ways:
- Comparative amounts for the prior period(s) where the error occurred should be restated
- Restatement of the opening balances of assets, liabilities, and equity for the earliest prior period shown if the error happened before that period.
With the exception that it is impractical to ascertain either the period-specific impacts or the cumulative effect of the inaccuracy, the prior period error/adjustment shall be remedied by retrospective restatement. Prior periods of error can only be corrected prospectively by the entity in cases where it is impossible to calculate the cumulative effect of an error.
The entity must include the following information when sharing this:
- The type of inaccuracy from the previous period
- For each financial statement line item and for each prior period presented, to the degree practical, the amount of correction for each prior presented.
- starting from the earliest prior period, the amount of the correction
- If retrospective restatement for a specific past period is not feasible, describe the facts that gave rise to the problem, as well as how and when the error was fixed.
- They need not be repeated in financial statements for succeeding quarters.
The Previous Period mistake and adjustments are frequently seen negatively by the company's stakeholders, who assume that the company's accounting system was flawed.
Nonetheless, it is preferable to avoid such changes where the magnitude of the change is unimportant to accurately depict a company's performance and financial position.