Definition of Prior Period Adjustments
Prior period adjustments mean the correction of the accounting errors and omissions that are detected in the financial statements of a prior period after they are approved. The correction of these errors is done by a restatement of the comparative amounts of the prior period that is being presented in which errors are there; the carrying amounts of assets, liabilities, and equity are to be adjusted in case the errors occurred before the periods being presented.
Some kinds of errors or omissions may be found in the financial statements of a particular accounting year afterwards. These errors can be due to various reasons like mathematical error, clerical error, accounting policies wrongly applied, or misinterpretation of facts. To correct these mistakes and omissions, an adjustment is required to be made in the financial statements in a retrospective manner so that the current financial statements are free of any error.
If the prior period in which error has been detected is being presented as a comparable year in the current financial statements, then the comparable amounts in that prior year are restated by the correct amounts. However, if the prior period in which error is detected doesn’t form part of the presentation of the current financial statements, then the carrying amounts of the affected assets, liabilities, and equity are to be restarted for the earliest prior period that is being presented along with prospective prior years.
Example of Prior Period Adjustments
Let us understand prior period adjustments with the help of an example.
In the financial statements of a company, the depreciation amount was wrongly calculated for the year ended 31st December 2018, and as a result, the values of property, plant & equipment, depreciation, and profit and loss amounts were affected. In the below extract of the current financial statements, we can see that the year 2018 is presented as a comparable year. Thus, all the comparable amounts of all the affected items (being 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 being 2019, are to be simultaneously restated. 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 way of restatement of financial statements as 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 basis 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 there in the profits due to shifting from one valid basis to another, an adjustment is required to be calculated so that business receipts are not taxed again and deductions are not allowed again. For tax purposes, the prior period adjustments are to be treated either as receipts or deductions while calculation of the business profits.
If the changes are due to an invalid basis, then tax laws require that they be corrected in the period in which they occurred first and correction 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 way of restatement of amounts in the prior period being presented in which error occurred. The restatement has to be made prospectively for other prior periods reported as well.
However, when the prior period in which the error first occurred is not presented 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 too.
Prior period adjustments are required to be carried out to incorporate the accounting effect of those material errors or omissions that took place in a prior year after its reporting.
This is a guide to Prior Period Adjustments. Here we also discuss the definition and prior period adjustments tax return along with an example. You may also have a look at the following articles to learn more –