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The American Institute of Professional Bookkeepers
 VOLUME 1: Issue 20

Correcting errors after the books are closed

It's generally around now that you may discover a possible error in last year's books-a revenue or expense omitted or inaccurately recorded in 2004. You cannot correct the 2004 revenue or expense accounts because they have been closed out. What can you do? We offered AIPB members an easy solution in their monthly technical briefing, The General Ledger newsletter ( We hope that you can use this valuable information.

Problem: How do you correct an error in revenues or expenses made in 2004, but not discovered until 2005, after the 2004 books are closed?

Solution: At year-end, net income is closed out to Income Summary, which is then transferred to the owners' equity account Retained Earnings (corporations) or Capital (partnerships, sole proprietorships). Thus, this account includes last year's net revenues and expenses. To add back omitted revenues, you credit Retained Earnings or Capital and to add back expenses, you debit one of these accounts. To summarize:

  • To correct an expense omitted or understated in 2004 after the books are closed, debit Retained Earnings (or Capital) to reduce the balance.
  • To correct an expense overstated in 2004 after the books are closed, credit Retained Earnings (or Capital) to increase the balance.
  • To correct revenue omitted or understated in 2004 after the books are closed, credit Retained Earnings (or Capital) to increase the balance.
  • To correct revenue overstated in 2004 after the books are closed, debit Retained Earnings (or Capital) to reduce the balance.

    Problem: TiCo fails to accrue $10,000 insurance expense for 2004. If TiCo discovers the error after the 2004 books are closed, what entry does it record?


          Retained Earnings*      10,000
                Insurance Payable                 10,000

    * The debit could also be to Prior Period Adjustment-Insurance Expense. By using Prior Period Adjustment-[description of error] instead of Retained Earnings, a series of descriptive entries is created for each prior period error correction-i.e., Prior Period Adjustment-Commission Revenue, Prior Period Adjustment-Rent Expense, etc. Retained Earnings is then adjusted by net Prior Period Adjustment debits and credits.

    The correcting entry reduces the balance in Retained Earnings, which includes net income from 2004. If TiCo presents comparative statements for 2004 and 2005, they will have to be restated to present the correct income for both years.

    If the error is material, consult your CPA; your company or client may have to file an amended tax return.

    If you have major bookkeeping responsibilities for your company or clients, we would like to keep you fully up to date on the latest changes in IRS reporting requirements, in rules on owner v. employee use of company and personal cars or other vehicles, on expense deductions and reimbursements, on important news from your state, on key developments reported in other accounting and tax publications that you may have missed.

    Join today and get your first monthly technical briefing, the June issue of The General Ledger, with important June updates for you on:

  • Changes that make flexible spending accounts (FSAs) more valuable by making the cost of nonprescription drugs (antacids, allergy medicines, pain relievers, cold treatments, etc.) reimbursable by an FSA-and when these reimbursements might be taxable
  • Why you no longer have to submit suspicious W-4s to the IRS-but why you may get an IRS notice anyway
  • Why fees for lines of credit are tax deductible
  • Fast-spreading, strict new laws on "SUTA dumping" (see if your state is mentioned in this issue of The General Ledger)
  • 10 vital tips on W-4s from Ernst & Young that will help you avoid IRS penalties
  • Why the IRS will scrutinize your fringe benefits to highly paid employees if your company is audited for any reason (even one that has nothing to do with fringe benefits)
  • Why a new court case could let you off the hook as a "responsible person" for employment taxes-even if you sign company checks
  • A monthly bookkeeper's skills-and-knowledge quiz (do you know the answers?)

    Why miss important bookkeeping, accounting or tax news that affects your job, your company or your clients? Connect with 30,000 bookkeepers in the national association and certifying body for your profession. Join today by clicking here:

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