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Chapter20: Accounting Changes and Error Corrections

Part B: Correction Of Accounting Errors

p. 1152

Nobody's perfect. People make mistakes, even accountants. When errors are discovered, they should be corrected.14 Graphic 20-10 describes the steps to be taken to correct an error, if the effect of the error is material.15

 

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GRAPHIC 20-10
Steps to Correct an Error

The retrospective approach is used for the correction of errors.

The correction of an error is treated as a prior period adjustment.

 

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14 Interestingly, it appears that not all accounting errors are unintentional. Research has shown that firms with errors that overstate income are more likely “to have diffuse ownership, lower growth in earnings and fewer income-increasing GAAP alternatives available, and are less likely to have audit committees,” suggesting that “overstatement errors are the result of managers responding to economic incentives.” M. L. DeFond and J. Jiambaolvo, “Incidence and Circumstances of Accounting Errors,” The Accounting Review, July, 1991.

15 In practice, the vast majority of errors are not material with respect to their effect on the financial statements and are, therefore, simply corrected in the year discovered (step 1 only).

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