Understand Accounting Fundamental Errors

November 13th, 2006 Comments off
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Earlier we have discussed in details changes in accounting estimates and changes in accounting policies.

In this article, we look at what are Fundamental Errors and how do we deal with them. Next we compare Fundamental errors with errors in accounting estimates.

Fundamental Errors

Basics:

  • Errors are bound to arise whenever judgement has to be exercised.

  • However, fundamental errors are errors discovered in the current period that are of such significance that the financial statements of one or more prior periods can no longer be considered to be reliable at the date of their issue and normally comprises the following:-

     · Error of mathematics such as casting error in a stock count;

     · Error in applying accounting principle such as a bad debt expense posted to an asset account, an unrealized profit on intra-group transaction not eliminated on consolidation and a finance lease transaction not capitalized;

     · Misinterpretation of facts such as deferred tax expense computed on an incorrect interpretation of tax law or

     · Frauds and oversight such as recogniztion of material amounts of work-in-progress and receivables in respect of fraudulent contracts which cannot be enforced.

From practical point of view, it is rare to have mathematical errors as fundamental error. Normally, fundamental errors relate to application of a wrong account principle such as an incorrect interpretation of a certain laws or statutes.

Salient points to note:

 

Errors in Accounting estimates Vs Fundamental Errors

Errors in Accounting estimates:

  • Don’t be confused with errors in accounting estimates like over or under provision for doubtful debts or errors in stock-down, depreciation under-provided and over or under provision for taxation. Errors in accounting estimates are due to the need to use judgement and the information available at the time the estimates were made.
  • Any over/under provision say doubtful debts, stock write down, under provision for taxation when discovered is corrected in the current year by increasing or decreasing the provision.

Fundamental errors:

  • Unlike errors in accounting estimates, fundamental errors render the financial statements of one or more prior periods to be UNRELIABLE.
  • Once detected, the challenge is whether the error should be corrected in the latest reporting period or whether the error should be corrected in the financial statements of the prior period ( adjusted retrospectively or retroactively) that is presented together with the financial statements of the current period
  • In practice, it is generally considered more appropriate to correct for fundamental errors retrospectively by a prior year adjustment. The prior year adjustment should be net of taxes if tax effects are applicable.

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