Updated July 15, 2023
Definition of Prior Period Adjustments
Prior period adjustments mean correcting accounting errors and detecting omissions in the prior period’s financial statements after approval. The correction of these errors is done by a restatement of the comparative amounts of the preceding period that is being presented in which errors are there; the carrying amounts of assets, liabilities, and equity are to adjust in case the errors occur before the presented periods.
Some kinds of errors or omissions may find in the financial statements of a particular accounting year afterward. These errors can be due to mathematical errors, clerical errors, incorrect accounting policies, or misinterpreting facts. To correct these mistakes and omissions, an adjustment must be made in the financial statements retrospectively so that the current financial statements are free of errors.
Suppose the prior period in which the error was detected presents as a comparable year in the current financial statements. In that case, the comparable amounts in that previous year are restated by the correct amounts. However, suppose the prior period in which the error detect doesn’t form part of the presentation of the current financial statements. In that case, the carrying amounts of the affected assets, liabilities, and equity will restart for the earliest prior period presented along with prospective prior years.
Example of Prior Period Adjustments
Let us understand prior period adjustments with the help of an example.
A company’s financial statements wrongly calculate the depreciation amount for the year ended 31st December 2018. As a result, property values, plant & equipment, depreciation, and profit and loss amounts were affected. In the below extract of the current financial statements, we see that 2018 presents as a comparable year. Thus, all the comparable amounts of all the affected items (property, plant & equipment, depreciation, and profit and loss) are to be restated to the correct figures. Also, the opening balances of the next prior year, 2019, are to restart simultaneously. You may refer to the extract of the balance sheet showing how figures in non-current assets are restated for the prior years, 2018 and 2019.
Balance Sheet Extract as of 31st Dec 2020
|Particulars||Note||31st Dec 2020||31st Dec 2019 Restated*||31st Dec 2018 Restated*|
|Property, plant, and equipment||17||$25,621||$32,542||$34,298|
|Intangible assets and goodwill||18||$6,732||$4,524||$5,321|
|Investments accounted for using the equity method||20||$4,532||$4,132||$3,276|
|Other long-term assets||21||$2,843||$3,217||$2,186|
|Total Non-Current Assets||$40,320||$45,382||$45,318|
This is how prior period adjustments are made by restating financial statements per the accounting standards.
Prior Period Adjustments Tax Return
As per UK tax laws, there can be two types of basis on which prior period adjustments are made. Changes can be made in the profits of a business either due to a shift from one valid base to another valid basis (such as a change in accounting policy) or due to an invalid basis (such as material error identified in the books of accounts).
When changes are in the profits due to shifting from one valid basis to another, an adjustment must calculate so that business receipts are not taxed again, and deductions are not allowed again. The prior period adjustments are treated as receipts or deductions for tax purposes while calculating the business profits.
If the changes are due to an invalid basis, then tax laws require that they be corrected in the period they occur first and corrected in the tax returns of the subsequent periods.
Prior Period Adjustments to Retained Earnings
The International Financial Reporting Standards require that the prior period adjustments be made by restating amounts in the prior period present in which the error occurred. The restatement must be made prospectively for other previous periods reported.
However, when the prior period in which the error first occurred is not present as a comparable year, then the carrying amounts of the assets, liabilities, and equity will have to be restarted for the earliest prior period which is being presented.
Thus, for errors that call for changes in profit and loss items for the prior period, which is not presented, a prior period adjustment can be made to the carrying amount of the retained earnings for the first prior period being presented and prospectively for other prior periods.
Prior period adjustments must be carried out to incorporate the accounting effect of those material errors or omissions that occurred in a prior year after its reporting.
This is a guide to Prior Period Adjustments. Here we also discuss the definition, prior period adjustments tax return, and an example. You may also have a look at the following articles to learn more –