Chapter 5: Errors

Errors might occur in the recognition, measurement, presentation or disclosure of elements of financial statements. Financial statements do not comply with IFRS if they contain material errors. They also do not comply if they contain immaterial errors that have been made intentionally to achieve a particular presentation of an entity’s financial position, financial performance or cash flows. An entity should correct material prior period errors retrospectively, by amending comparatives and restating retained earnings at the beginning of the earliest period presented in the first set of financial statements authorized for issue after their discovery.

Identifying prior period errors

Management might discover material errors that relate to one or more prior periods for which financial statements have already been issued. These errors are corrected by adjusting the comparative information for the periods affected that are included in the current period’s financial statements.

The term ‘prior period errors’ refers to:

“… omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

1. was available when financial statements for those periods were authorized for issue; and
2. could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.

Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.”

Determining whether or not there has been an error in a prior period requires consideration of whether there was reliable information available that could have reasonably been obtained at the time when the error was made. The Framework discusses ‘faithful representation’ as one of the fundamental qualitative characteristics of financial statements, which IAS 8 states is a feature of ‘reliability’. The Framework states that:

“Faithful representation does not mean accurate in all respects. Free from error means there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process. In this context, free from error does not mean perfectly accurate in all respects.

For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate. However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate.”

How to determine whether reliable information was available when financial statements for prior periods were authorized for issue? Determining whether or not there has been an error in a prior period requires that reliable information was available and could have reasonably been obtained at the time when the error was made. In some cases, it might be clear that reliable information was available. For example, management might overlook the available evidence, in the form of an invoice or creditor’s statement, resulting in the under-accrual of a significant expense item. In other cases, it might be more difficult, especially if there has been a deliberate manipulation of results or fraud. This is because management might have deliberately suppressed or destroyed reliable information or created false and unreliable information in order to conceal or justify incorrect accounting. The errors in these cases would usually still qualify as prior period errors even though management cannot quantify except by using relevant information that emerges in a future year and reconstruct the accounting records related to the earlier period in that future year. This is because, in many situations, reliable information would have existed in the prior periods, and a reasonable person, who was not involved in making the error, would have obtained and used that information (or, if it was already available, would not have suppressed or destroyed it).

Distinction among changes in accounting policies, accounting estimates and correction of prior period errors

An entity should distinguish the correction of errors from changes in accounting estimates. On the one hand, management can revise estimates to reflect the prevailing circumstances and to take account of the latest information. This is because of the inherent uncertainty over the amounts recognized previously.

Errors, on the other hand, result from the deliberate or accidental misuse of, or disregard for, information that is or should be available. For example, a gain or loss recognized on a contingent outcome, that an entity could not reliably estimate previously, does not constitute an error correction.

IFRS IC agenda decisions: correction of prior period errors or change in accounting policies Question: The IFRS IC often receives submissions relating to newly identified financial reporting issues. It decides whether or not to add the issue to its agenda. It might decline to add an issue to its agenda for various reasons. One of those reasons is that it determines that the requirements in IFRS Standards provide an adequate basis for an entity to conclude. IFRS IC agenda decisions do not form part of IFRSs; however, they often provide clarification; and some stakeholders expect preparers to consider IFRS IC agenda decisions. The IFRS IC stated in the March 2019 IFRIC Update that “The process for publishing an agenda decision might often result in explanatory material that provides new information that was not otherwise available and could not otherwise reasonably have been expected to be obtained”. Therefore, an entity might change its previous accounting treatment following the issue of an IFRS IC agenda decision. Should an entity treat such a change as a correction of a prior period error or a change in accounting policy? Answer: Management might have applied an accounting policy based on a reasonable interpretation of the relevant standard, considering the available IFRS guidance at that time. As explained above, agenda decisions often provide explanatory material, that provides new information ‘that was not otherwise available and could not otherwise reasonably have been expected to be obtained’. Therefore, changes applied in response to an agenda decision often result in voluntary accounting policy changes in accordance with IAS 8 as they arise from ‘new information’. An entity should apply IAS 8 to determine the nature of and provide sufficient disclosure of the reasons for the change, having regard to the particular facts of the individual case. Entities might consider the following description for the change in accounting treatment: “The group previously accounted for [explanation of previous accounting practice]. Following the IFRS IC agenda decision, the group has reconsidered its accounting treatment. The group has adopted the treatment set out in the IFRS IC agenda decision [description of the new treatment]. This change in accounting treatment has been accounted for retrospectively and comparative information has been restated. [Disclose details of the effect.].” Entities should also consider the views of the relevant regulator when assessing and describing the change.

Determining materiality

An entity should evaluate whether a prior period error is material and warrants adjusting the financial statements retrospectively. Omissions or misstatements of items are material “if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements”.

On 31 October 2018, the IASB issued amendments to the definition of material in IAS 1 and IAS 8. A deliberate misstatement, or a misstatement to achieve a particular result, could also be material. An entity should consider both the qualitative and quantitative (that is, nature and magnitude) impact of the error and its correction method.

It should not assess materiality solely against a single year or a single measure, such as the profit for the year or retained earnings, but rather against the financial statements as a whole. An entity might also need to consider the relevant regulator’s views.

Immaterial prior period error Question: How should an entity account for a prior period error that is not material to the prior period financial statements? Answer: It might be acceptable to correct an error that is not material to the prior period financial statements in the current period rather than retrospectively. However, management should evaluate whether such an approach would result in a material error in the current period, taking into account both qualitative and quantitative factors. Management should generally restate comparative amounts if a correction in the current period would materially misstate the financial statements in that period.

Regulators’ consideration on materiality in respect of correction of accounting errors Where management assesses the impact of a prior period error, it also needs to be aware of any specific regulatory requirements in addition to the guidance provided under IFRS. For example, the SEC has indicated that an IFRS preparer listed in the US that that does not intend to apply Staff Accounting Bulletin 108 (‘SAB 108’) should first consult with the SEC staff. SAB 108 requires that an entity consider two methods of evaluating errors: (a) ‘iron curtain’ – correcting the cumulative impact of an error that remains in the balance sheet through the income statement of that period; and (b) ‘rollover’ – the amount by which the income statement is actually misstated. We consider that the approach in SAB 108 is an acceptable approach for determining whether an error is material under IFRS. Accounting for tax effects of a prior period adjustment

Correction of prior period errors

An entity accounts for the restatement of financial statements for a material prior period error in a manner similar to a change in accounting policy. It should correct a material prior period error by retrospective restatement in the first financial statements issued following the discovery of the error, except where it is impracticable. Retrospective restatement refers to “correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred”. Such restatement is achieved by:

• restating comparative amounts for the prior periods presented in which the error occurred; or
• if the error occurred before the earliest prior period presented in the financial statements, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

An entity excludes the correction of a material prior period error from the income statement for the period in which the error is discovered. However, a correction is included in the current period income statement to the extent that the amount attributable to a prior period cannot be determined.

This is because, for example, it might just as easily relate to the current period. This means that assets, liabilities and equity for prior periods might be partially adjusted, as indicated by IAS 8, but will be fully adjusted and corrected by the end of the current period.

An entity should also adjust any information presented in the form of an historical summary where the restated financial information is included in the same document by restatement from the earliest date practicable. For example, five-year summary of selected financial information in annual report.