Financial statements provide an overview of the financial health and stability of a business. One of the main purposes of financial information is to provide shareholders and investors with accurate information so that they can make appropriate decisions. Therefore, it is vital to accurately report financial information. Even the smallest mistake that may seem irrelevant can have a major impact on important financial ratios. Companies are required to report corrections to errors as prior period adjustments, including that changes were required to prior period financial statements. It is vital that the total values of assets and liabilities from previous periods are adjusted for a cumulative effect. This cumulative effect will be equal to the necessary adjustment to the balance of retained earnings. Some common accounting errors include mathematical errors, unrealistic estimates, failure to increase expenses or income at the end of a period, misuse of facts, and misclassification. However, there is a fine line between a mistake and a fraud. Fraud is a crime in which people or companies knowingly provide incorrect information for personal gain. Companies can commit fraud in a variety of ways for a variety of reasons; it is a serious matter that ultimately misrepresents the financial position of the company.
The moment a business finds a reporting error, the error must be corrected. The company corrects errors from prior periods by making an adjustment to its retained earnings for the current accounting period. These transactional corrections are later called prior period adjustments. When estimates are needed, it is important to use realistic and accurate numbers, so that the quantities involved are accurate. Estimates that are related to depreciation expense can be vital in creating your bottom line. If depreciation expense is overestimated, the company’s net income will be underestimated. At the same time, if a company underestimates depreciation expenses, it will have a higher net income. Consequently, estimates and non-cash expenses have a significant impact on a company’s results; therefore, it should be reported as accurately as possible. If a company recognizes that a change in an estimate must be made, the company should use the new configured basis to report current and future financial statements. However, no changes will be made to the financial statements for the prior period. In addition, the opening balances of the current period should not be adjusted due to the effects in previous periods.
If a company needs to change the way it reports to the entity, it must do so retroactively. Therefore, the company must restate its financial statements from previous periods. They must also provide the reason and nature of the change and the effect of the change on bottom line and earnings per share for all periods presented above.
When a company needs to change its accounting principle, it must do so retroactively. A change in accounting principle is when a company changes from one generally accepted accounting principle to another: for example, if the United States were to adopt International Financial Reporting Standards, companies would have to retroactively change their financial statements that they recorded under the Generally Accepted Accounting. Beginning. Therefore, if a change of principle occurs, a company must change its financial statements for all periods presented above. The year in which the accounting principle occurs, the company must disclose the effects of net income and earnings per share that occurred during the previous periods. An adjustment to the balance of retained earnings must also be completed in the first year presented. If you decide to switch from FIFO to LIFO, it is not practical to determine the effects that occur during the periods previously recorded. Therefore, the company will not modify the income of previous years. For all subsequent LIFO calculations, the company must use the beginning inventory for the year the method is adopted as base year inventory. Finally, the firm must disclose the effects that occurred and specify the reasoning behind omitting the calculation of the cumulative effect and the pro forma amounts.
There is a fine line between an accounting error and a change and the commission of the crime of fraud. Businesses and individuals often commit fraud for financial gain. Therefore, fear of losing your job, difficult financial goals, personal bonuses, and maintaining financial performance are all factors that come into play. For example, there are two days to the end of the period and you only have a few sales to go to earn that big bonus, but it doesn’t look like you’re going to get there. So you decide to make a deal with a close contact to buy some inventory that you will buy back after the period. This is a case of misrepresentation of sales to collect, which is fraud. As you can see, there is a clear difference between an accounting error and a change regarding fraud. Errors, changes, and fraud are important components of the accounting profession. Attempts should be made to prevent fraud proactively through internal control, while errors and changes should be dealt with prospectively or retrospectively, as necessary.