What is Counterbalancing errors?
In short
Counterbalancing errors are errors that reverse themselves over two periods, such as an overstatement of ending inventory, which overstates this year's income and understates next year's by the same amount.
Key takeaways
- After the second year's books are closed, retained earnings is correct.
- If found during the second year, retained earnings is corrected through a prior period adjustment.
- Comparative statements are still restated if the earlier year is presented.
Example
Ending 2025 inventory overstated by $10,000: 2025 income is $10,000 too high, 2026 income $10,000 too low, and retained earnings is right at the end of 2026.
Where it's tested
FAR: Accounting Changes & Error Corrections — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
Ending inventory for Year 1 was understated by $10,000, and the error was never corrected. Ignoring taxes, what is the effect on Year 2?