FRS 102/FRS 105: Error Correction
Many practitioners ask whether an error that has been noted in the financial statements of a client for the previous year can be corrected in the current year or if it has to be corrected retrospectively as a prior year adjustment. Error correction is dealt with in FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland in Section 10 Accounting Policies, Estimates and Errors.
The term ‘errors’ is defined in the Glossary to FRS 102 as:
‘Omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, information that:
(a) was available when financial statements for those periods were authorised for issue; and
(b) could reasonably be expected to have been obtained and taken into account in the preparation of those financial statements.’
Error correction is dealt with in FRS 102 (March 2018) at paragraphs 10.19 to 10.23 and in FRS 105 (March 2018) The Financial Reporting Standard applicable to the Micro-entities Regime at paragraphs 8.14 to 8.17.
The definition above is also contained in FRS 102, para 10.19. FRS 102, para 10.20 confirms that errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.
Errors versus accounting estimates
Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of the financial statements. Errors are distinct from accounting estimates because accounting estimates (by their very nature) require amendment as additional information becomes known. Errors, on the other hand, arise when information was available but was either not used or not found; or an accounting error (including a calculative error) was made in respect of an item.
| Example |
| The financial statements of Smith Limited for the year ended 31 March 2019 contained certain types of expenditure which were believed to be allowable for corporation tax purposes and hence tax relief was claimed in the corporation tax computation for the year then ended.
HMRC subsequently opened an investigation into the company’s tax return for the year ended 31 March 2019 and disallowed the expenditure. Would this constitute an error? Answer No, on the basis that there were reasonable grounds at the time to assume the expenditure was allowable for tax purposes. At the time of preparing the tax computation, it was believed that the expenditure was allowable. |
| Example |
| Jasper Ltd is a small company which prepares its financial statements under FRS 102, including Section 1A. For the year ended 31 December 2018 the company did not make a provision for deferred tax in its financial statements in respect of a gain on the fair value uplift of its investment property on the grounds that the finance director was unaware she had to make such a provision.
Is this an error? Answer Yes. Even though the company is a small company, it must still apply the recognition and measurement requirements of full FRS 102 (Section 1A only deals with presentation and disclosure). FRS 102, para 29.16 requires deferred tax to be brought into account for investment property. Assuming the error is material, the error must be corrected by way of a prior period adjustment. |
Correcting errors in the financial statements
Errors must be corrected by way of a prior year/period adjustment if the error is material. FRS 102 refers to the correction of material prior period errors but does require only material prior period errors to be corrected retrospectively. However, if the error(s) is immaterial, then it would be acceptable to correct them in the current year as the standard is silent on the correction of immaterial errors (presumably because accounting standards only apply to material items).
Materiality is a matter that involves professional judgement so care must be taken to ensure that errors are corrected appropriately as either current year adjustments or prior period adjustments. It is always advisable to document the reasons for making conclusions where professional judgement is concerned.
There is a difference in this accounting under FRS 102 than was the case under previous UK GAAP. Under old UK GAAP, an error was corrected by way of a prior period adjustment if that error was fundamental. A fundamental error was defined in old FRS 3 Reporting financial performance as one which destroyed the true and fair view of the financial statements and the validity of the financial statements. Hence, under FRS 102 the error does not need to be fundamental to require correction by way of a prior period adjustment (it needs to be material) and therefore more errors are corrected retrospectively under the current regime in comparison to old UK GAAP.
FRS 102, para 10.21 says:
‘To the extent practicable, an entity shall correct a material prior period error retrospectively in the first financial statements authorised for issue after its discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.’
If it is impracticable to determine the period-specific effects of a material error on comparative information for one or more prior periods presented, FRS 102, para 10.22 requires the entity to restate the opening balances of assets, liabilities and equity for the earliest period for which retrospective restatement is practicable (which may be the current period).
Disclosure of prior period errors
FRS 102, para 10.23 requires the entity to disclose the following about material prior period errors:
(a) the nature of the prior period error;
(b) for each prior period presented, to the extent practicable, the amount of the correction for each financial statement line item affected;
(c) to the extent practicable, the amount of the correction at the beginning of the earliest prior period presented; and
(d) an explanation if it is impracticable to determine the amounts to be disclosed in (b) or (c) above.
Financial statements of subsequent periods need not repeat these disclosures.’
When prior period figures have been restated, some automated accounts production software systems may present the comparative columns ‘As restated’ on each page of the financial statements. While this is considered to be best practice (as it flags up that changes have been made since the comparative year’s financial statements were first authorised for issue), there is no requirement to do this.
Impracticability
The term ‘impracticable’ features a couple of times in the corrections of prior period errors section of FRS 102. The term itself is defined as follows:
‘Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so.’
Undue cost or effort is irrelevant under FRS 102 (March 2018) as these concepts were removed during the triennial review so an entity would not be able to justify that undue cost or effort is an excuse for not complying with something in the standard. In any event, the entity must make every reasonable effort to apply a requirement before it concludes that it is impracticable.
Conclusion
It is likely that more errors will be corrected retrospectively through a prior period adjustment because FRS 102 (and FRS 105) require material errors to be corrected. What is, and what is not, material will all depend on the client and so this will involve professional judgement being applied.
Category: Accounting and standards, Audit
