|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 (www.aipb.org/general_ledger.html). 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:
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.
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