Prior Period Adjustment

A prior period adjustment is an accounting term used to describe a correction to an error in previously issued financial statements. These adjustments are necessary to accurately reflect the financial status of a company or organization.
On this page

Definition

A Prior Period Adjustment (PPA) is an accounting technique used to correct errors made in previous financial statements. These errors might include mathematical mistakes, incorrect application of accounting principles, or overlooked expenditures or incomes. Prior period adjustments ensure that the financial data accurately reflects the historical financial health of the organization and aligns the financial records with Generally Accepted Accounting Principles (GAAP).

Key Points:

  • Correction of Errors: Prior period adjustments are primarily used to fix mistakes from previous accounting periods.
  • Impact on Retained Earnings: Adjustments are generally made by altering the beginning retained earnings balance of the earliest period presented.
  • Compliance with Standards: Accountants must follow guidelines provided by the Financial Accounting Standards Board (FASB) for making these adjustments.

Examples

  1. Inventory Adjustment: Suppose a company discovers that it incorrectly reported its inventory balance the previous year, leading to an overstatement of income. A prior period adjustment would be made to correct the inventory balances and adjust the retained earnings accordingly.
  2. Litigation Settlement: If a company settles a lawsuit that relates to an event from a past accounting period, the payment should be accounted for as a prior period adjustment if it wasn’t adequately recorded when the event occurred.

Frequently Asked Questions

Q1: When should a prior period adjustment be made?

A1: A prior period adjustment should be made when a significant error affecting prior financial statements is discovered. Materiality and relevance are key factors in determining the need for an adjustment.

Q2: Will a prior period adjustment affect current year earnings?

A2: No, a prior period adjustment should not affect current year earnings. The correction is usually reflected in the retained earnings account from the earliest period presented.

Q3: Where are prior period adjustments recorded in financial statements?

A3: Prior period adjustments are typically recorded in the statement of retained earnings, which is part of the Statement of Changes in Equity, and are prominently disclosed in the notes to the financial statements.

  • Retained Earnings: The cumulative amount of net income that a company retains rather than distributing it to shareholders as dividends.
  • Restatement: The process of revising previously issued financial statements to correct an error.
  • Materiality: The significance of financial statement information to influence the economic decisions of users.
  • GAAP (Generally Accepted Accounting Principles): A collection of commonly followed accounting rules and standards for financial reporting.

Online References

Suggested Books for Further Studies

  1. Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
  2. Financial Accounting Theory and Analysis: Text and Cases by Richard G. Schroeder, Myrtle W. Clark, and Jack M. Cathey
  3. Accounting Principles by Jerry J. Weygandt, Donald E. Kieso, and Paul D. Kimmel

Fundamentals of Prior Period Adjustment: Accounting Basics Quiz

Loading quiz…

Thank you for taking the time to understand prior period adjustments in-depth! Continue your studies to stay proficient in accounting principles and practices.

Prior Service Cost
Printout