Prior Period Adjustment to Financial Statements
Prior period adjustment is the correction of accounting error to the financial statement in the past year which already completed. It is the adjustment that will impact the past financial year as well as the subsequent report. It is a way to go back and fixed the error which has made in the past year. We have to ensure that all these adjustments must carry forward to the next and current year’s financial statement.
Prior period adjustment happens due to errors in calculation, accounting treatment, and wrong translation of financial information.
The prior period adjustment must be correct retrospectively in the financial statement. If the adjustments relating to change in revenue and expense in the past period, they should be reflected with the retained earnings of the current year. As the past year’s income statement already carries forward to the retained earning account. So if we want to carry forward the adjustment, we need to change from income statement to retained earnings account.
Prior Period Adjustment Example
Company A has prepared a financial statement for the year 202X. Two years later, in 202X+2, they just realize that operating expenses were understated of $ 100,000. It happens due to the wrong calculation of depreciation expense. Please prepare journal entries for the year 202X, 202X+1, and 202X+2. Assume all three years’ financial statements are separated, so we have to adjust them manually.
We have to prepare journal entries for these three years as follows.
- To record additional depreciation expense which is understated in 202X.
| Accounts | Debit | Credit |
|---|---|---|
| Depreciation Expense | 100,000 | |
| Accumulated Depreciation | 100,000 |
- To carry forward the adjustment from 202X to 202X+1, we have to adjust the following transaction:
| Accounts | Debit | Credit |
|---|---|---|
| Retained Earnings | 100,000 | |
| Accumulated Depreciation | 100,000 |
- To carry forward the adjustment from 202X to 202X+2, we have to adjust the following transaction:
| Accounts | Debit | Credit |
|---|---|---|
| Retained Earnings | 100,000 | |
| Accumulated Depreciation | 100,000 |
Note: we make the adjustment three times because they are separated financial statements. If we use the accounting software, we need to make only one transaction in 202X and the system will auto brought forward into 202X+1 and 202X+2 and we do not need to repeat the adjustment. This example just to illustrate the implication from one report to next year’s report.
