Error correction in financial statements

This article answers the following questions:

• When should financial statements be adjusted?
• How to adjust financial statements?
• What errors in financial statements are considered immaterial?

Errors in annual financial statements may happen to any business and are far from being uncommon. Unfortunately, it is often the case that misstatements are not detected in time and become apparent only after the financial statements are signed, or even approved. However, according to the Polish National Accounting Standard No. 7, all businesses are obliged to correct detected errors – regardless of whether they concern the current financial year or previous ones. What exactly does this procedure involve?

Error materiality assessment

More often than not, errors in financial statements result from:

• miscalculations and oversights,
• misinterpretation of regulations or economic events,
• source documentation that is incomplete or includes misstatements,
• incorrect allocation of revenues and costs to given periods.

Errors in financial statements are considered material if, individually (or collectively), they may influence the economic decisions made by entities based on the data included therein.

If an error discovered after the approval of the financial statements does not distort the financial statements for the current financial year (or for previous years), it is considered immaterial, should be recognised in the current year's accounting records and treated as a current transaction. However, immaterial errors should be considered collectively in the process of auditing financial statements, as their aggregate effect may lead to a distortion of the financial statements.

Correcting errors in approved financial statements

If the detected error concerns a version of the financial statements that has already been approved, it becomes impossible to make adjustments to the document as such. In such a case, the entity must record any restatements in the current year's accounts (i.e., the year in which the error was detected).

An error detected in the financial statements should be recognised in the balance sheet in two places:

• under the item "Profit (loss) from previous years" – where the value influencing the increase/decrease of the financial standings declared in previous years is given,
• under the balance sheet item that is associated with the cause of the error – for example the entity's provisions or liabilities.

Moreover, the additional information and explanations section should include a description of the misstatement that led to the adjustment of the annual financial statements. The explanations included in the additional information should specify:

• the reason for the misstatement,
• the value of the misstatement,
• a list of financial statement items affected by the error.

Any errors detected should also be exposed in the statement of changes in equity (if the entity is required to draft one).

Correction of financial statements that have not yet been approved

An error in unapproved financial statements may be corrected provided that it materially distorts the image of the entity resulting from the statements.

Errors detected in unapproved financial statements are corrected by opening the accounting books and entering appropriate adjustment entries.

It's worth remembering that the sooner appropriate corrective measures are implemented, the better. Transparency in communicating misstatements and making ongoing corrections builds trust in the entity and reduces financial risks, ensuring compliance with Polish and international regulations.

How to steer clear of errors in accounting records and financial statements?

An entity that wants to cut down the number of errors in financial statements and avoid the need for restatements should focus not only on ad hoc actions taken during year-end closing, but above all on systematic and comprehensive monitoring of accounting processes. This is why it is so important to conduct periodic, thorough internal audits that allow for the consistent implementation of solutions that minimise the risk of misstatements and ensure that reports are in full compliance with applicable regulations.

Steps that a business may take, with the help of a certified auditor, include:

• establishing multi-level verification of financial data,
• regular reviews of accounting books,
• training dedicated to the accounting team,
• automation of some accounting processes,
• drafting an accounting policy,
• creating checklists for key processes,
• archiving justifications for material accounting decisions.

If you need assistance with drafting or adjusting financial statements, please contact us. RSM Poland's statutory auditors will be happy to share their expertise and help you comprehensively implement procedures that ensure top-quality financial reporting.