Correcting Prior-Period Errors

Definition

A prior-period error is an omission from, or misstatement in, the entity's financial statements for one or more prior periods, arising from a failure to use (or a misuse of) reliable information that was available when those statements were issued and could reasonably be expected to have been obtained and taken into account (ASPE 1506.05).

Key rules

ASPE 1506 requires retrospective restatement of prior-period errors, unless it is impracticable to determine the period-specific effects or the cumulative effect of the error.

Steps for a correction:

1. Identify the error and quantify its effect on each affected period.
2. Restate the comparative figures on the balance sheet, income statement, statement of retained earnings, and cash flow statement.
3. Adjust the opening balance of retained earnings for the earliest period presented.
4. Disclose: the nature of the error, the amount of the correction for each prior period presented for each line item, the amount of the correction at the beginning of the earliest prior period presented, and (if applicable) the circumstances where retrospective restatement was impracticable.

Example

In the current year, management discovers that a $5,000 consulting invoice was never recorded in the prior year. Tax effect at 11% is $550.

Prior-year corrections:

Revenue                      +5,000   (prior year)
Accounts receivable          +5,000   (prior year-end balance)
Income tax expense             +550   (prior year)
Income taxes payable           +550   (prior year-end balance)
Net effect on retained
  earnings, prior year end   +4,450

On the current year's statements:

Retained earnings, beginning of year,
  as previously reported                        9,600
Correction of prior-period error, net of tax   +4,450
Retained earnings, beginning of year,
  as restated                                  14,050

The comparative income statement is restated to show revenue of $5,000 higher and the balance sheet comparative shows receivables $5,000 higher and income taxes payable $550 higher.

Common mistakes

• Putting a prior-year correction entirely through current-year income. This overstates current-year results and breaks comparability.
• Failing to disclose the restatement in the notes. The note must quantify the effect on each line and period.
• Treating a genuine error as an estimate change to avoid restating.
• Forgetting to amend tax filings where appropriate. A financial statement restatement often requires a T2 adjustment (T2 Schedule 1 or an amended return) and possibly revised T5 slips.
• Not restating cash flow statement comparatives. ASPE 1506 covers all primary statements, not just the balance sheet.

Related concepts

Error corrections contrast with voluntary policy changes and estimate updates. The restatement is reflected in the statement of retained earnings and in comparative figures.