What are the type of errors affecting financial statements?

2. Most common errors in financial reporting

Error Type 1 Error of Commission

The wide variety of errors come into this group, among them are:

  • Transposition errors, when the numbers are reversed, for example, 26 is written as 62.
  • Calculation errors, when the amount is deducted instead of adding.
  • Original entry errors, when an incorrect amount is posted to the correct account, for instance, recording $5,000 of advertisement expenses as $500.
  • Reversed entries, when the accounts used are correct, but the amount is debited instead of being credited, and vice versa.
  • Compensating errors, when two errors compensate each other, thus the trial balance balances. Attention should be put to such errors, as it may have been posted intentionally to conceal fraud.

Errors of commission may be corrected by the application of the general tips listed in the article below.

Error Type 2 Wrong Estimates

The most common example is an incorrect estimate of fixed asset useful lives. A company potentially has this error if:

  • there is a large number of fully depreciated fixed assets which are carried at zero book values, but the company still uses the assets;
  • the sale of a fixed asset leads to high profits.

To avoid making this type of error, management should perform annual reviews of fixed asset registers, pay attention to fully depreciated fixed assets which are still in use, and reassess asset useful lives where warranted.

Error Type 3 Incorrect Presentation of Current and Non-current Liabilities

At first glance, it looks quite simple to distinguish between current and non-current liabilities, as non-current liabilities are those falling due after 12 months. Often this error occurs if the company has a long-term loan repayable in installments, lease commitments, or non-current site restoring obligations. Despite the fact that there is only one contractual obligation, some part may be due within 12 months.

In order to reduce the risk of making this type of error, management should prepare a list of liabilities with their individual expected redemption dates and distinguish the portions repayable within the next 12 months:

  • Bank loans;
  • Finance lease commitments;
  • Bonds and debentures;
  • Restoration obligations;
  • Retirement benefits obligation.

Error Type 4 Deferred Tax Adjustments

Companies are required to account for both current taxes and the expected future tax consequences related to already recognized events. Deferred taxes arise due to differences between tax rules and accounting rules. Making correct deferred tax calculations and adjustments are crucially important for companies that prepare their financial statements in accordance with local GAAPs and then translate them into US GAAP.

To mitigate the risk of incorrect deferred tax in the financial statements, management should make deferred tax calculations only after all US GAAP transformation adjusting entries are posted.

Error Type 5 Failing to Apply Other Complex US GAAP Rules

Other complex US GAAP rules include the following:

  • Purchase of securities with embedded derivatives;
  • Consolidation of subsidiaries and special purpose entities;
  • Sale and leaseback contracts;
  • Finance lease agreements.
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