Substantial error and adjustment of financial result
In practice, after the balance sheet date, accounting ledgers are frequently found to contain errors which affect assessment of company’s financial situation or assets.
Errors in accounting ledgers occur when an entity does not adhere to adopted accounting principles (policy), or inaccurately and vaguely presents its financial situation, assets and financial result.
An error whose amount constitutes over 1-2% of balance sheet total, 0.5-1% sales revenue or which changes the financial result by over 5% may be regarded as a substantial error. The evaluation of significance of errors is subjective and it is made by the entity’s management board. Methods applied by certified auditors for auditing financial results may be used for determining the significance. Accounting policy should outline rules necessary for determining significance of such errors.
Correction of a substantial error in accounting ledgers depends on whether the financial statement concerned by the error was drawn up and approved.
A substantial error related with previous years, which is found after the balance sheet date and approval of financial statements for these years is corrected in the accounting ledgers of the year in which the error was found. Correction of such error is posted as an increase or a decrease, accordingly, of “accumulated profit (loss) from previous years” in a balance sheet in the group of equity.
A substantial error identified after balance sheet date, but concerning an accounting period which was not approved, is corrected in the accounting ledgers of the year which it concerns.
Non-substantial errors are corrected in accounting ledgers in the financial year in which they were found. Thus, non-substantial errors affect the amount of the financial result for the current financial year.
If an audited financial statement was corrected, it is necessary to inform a certified auditor about the adjustment made. In such a situation the certified auditor will assess the correction of an error and he may issue a new opinion and adjust a report from the audit.
The most common substantial errors are made as a result of incorrect calculation of costs of assets, inaccurate stocktaking of fixed assets or intangible fixed assets, and stocks or failure to comply with the principle of matching of revenue and costs in the consequence of irregularities in posting accruals and deferred income and the lack of provisions for creditors.
Substantial errors include also failure to calculate the amount of deferred tax by entities obliged under the Accounting Act to account for such tax.
Events such as merger or sale of entities, changes of prices of assets, marked changes of exchange rates, bringing an action to the court, that take place after balance sheet date, even if they considerably affect entity’s financial or asset assessment, do not require an adjustment of the financial result for previous years.
If an entity exercised due diligence when working out a financial statement, yet after balance sheet date a judgment was delivered, such financial statement is not subject to correction, and consequences of the judgment are included in the accounting ledgers of the current year. Such events should be described in notes to the financial statement for the previous year, if possible.