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Understanding Account Overstatements and Understatements

This document discusses error correction in accounting. It explains that an account can be overstated or understated and the relationship errors can have on related accounts, either direct or inverse. Errors in the current year can directly or inversely affect profit and retained earnings, depending on whether the account is asset- or liability-related. Current year errors only impact working capital if they involve current assets or liabilities. Errors from the previous year are automatically reversed in the next year's profit if they counterbalanced, while non-counterbalancing errors only impact the next year's retained earnings.

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Hazel Andrea Garduque Lopez
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13 views7 pages

Understanding Account Overstatements and Understatements

This document discusses error correction in accounting. It explains that an account can be overstated or understated and the relationship errors can have on related accounts, either direct or inverse. Errors in the current year can directly or inversely affect profit and retained earnings, depending on whether the account is asset- or liability-related. Current year errors only impact working capital if they involve current assets or liabilities. Errors from the previous year are automatically reversed in the next year's profit if they counterbalanced, while non-counterbalancing errors only impact the next year's retained earnings.

Uploaded by

Hazel Andrea Garduque Lopez
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

ERROR

CORRECTION
(PROBLEM 4)
A PRESENTATION ON AUDIT 2
BY:
JOHN MARTIN S. FLORES
OVERSTATED OR UNDERSTATED
 An account is said to be OVERSTATED if the reported amount is more than the
true or correct amount.
 An account is said to be UNDERSTATED if the reported amount is less than the
true or correct amount.
RELATIONSHIP BETWEEN
ACCOUNTS
 An understatement or overstatement of an account may either have a direct or
inverse relationship to another related account.
 Direct relationship means that if an account is understated, the related account is
also understated. Or if an account is overstated, related account is also overstated.
 Inverse relationship means that if an account is understated, the related account is
overstated. Or if an account is overstated, related account is understated.
EFFECTS OF ERRORS IN CURRENT YEAR
TO PROFIT AND RETAINED EARNINGS
 Asset-related accounts (prepaid assets, accrued income, etc.) have a DIRECT
relationship to profit and retained earnings.
 Ending inventory account has a DIRECT relationship to profit and retained
earnings.
 Liability-related accounts (accrued expenses, deferred revenue, etc.) have an
INVERSE relationship to profit and retained earnings.
 Beginning inventory account has an INVERSE relationship to profit and retained
earnings.
EFFECTS OF ERRORS IN CURRENT
YEAR TO WORKING CAPITAL
 Only CURRENT PERIOD ERRORS affect the working capital. Previous year
errors do not affect working capital.
 Only errors concerning CURRENT ASSETS AND CURRENT LIABILITIES
affect working capital.
 Current asset-related accounts have DIRECT relationship to working capital.
 Current liability-related accounts have INVERSE relationship to working capital.
EFFECTS OF ERRORS IN PREVIOUS YEAR
TO PROFIT AND RETAINED EARNINGS
 Effects of previous year’s counterbalancing errors are AUTOMATICALLY
REVERSED in the immediately following year’s profit.
 Previous year’s non-counterbalancing errors have NO effect on the profit of the
immediately following year.
 Only previous year’s non-counterbalancing errors affect retained earnings for the
immediately following year.
Reference Material: Intermediate Accounting 3
2020 Edition by Zeus Vernon B. Millan

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