CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A company discovers that it failed to record accrued salaries of $20,000 at the end of Year 1. The error was discovered in Year 2 before the financial statements for Year 2 were issued. The company uses a calendar year-end. How should this error be corrected, assuming the error is material?
- ADisclose the error in the footnotes to the Year 2 financial statements only.
- BRestate the prior period (Year 1) financial statements to correct Retained Earnings and Salaries Payable.
- CRecord an expense of $20,000 in Year 2's income statement.
- DAdjust current year's Salaries Expense and Salaries Payable by $20,000.
Show answer & explanationAnswer & explanation
Correct answer: B. Restate the prior period (Year 1) financial statements to correct Retained Earnings and Salaries Payable.
Material errors affecting prior period financial statements, if discovered before those statements are reissued or used, require restatement of the prior period financials. This involves adjusting the beginning balance of Retained Earnings (for income statement effects) and the relevant balance sheet accounts.
Why the other options are wrong
- A. Disclosure alone is insufficient for material prior period errors; restatement is required.
- C. Recording in Year 2 would misstate Year 2's income and would not correct the prior period's error.
- D. This would correct the balance sheet but misstate Year 2's expense and not correct Year 1's income.
Prior Period Adjustment (Error Correction)
The correction of a material error in previously issued financial statements, requiring restatement of prior period comparative financial statements and an adjustment to the beginning balance of Retained Earnings.
- Applies to material errors from prior periods.
- Financial statements of prior periods are restated.
- Beginning Retained Earnings for the earliest period presented is adjusted.
- Disclosure of the error and its impact is required.
Memory trick: Material Mistakes Mean Restate.