Immaterial errors....

What should company do with immaterial errors which arise in financial statements? Especially, when those errors are immaterial both: by quality and quantity.

Let`s look to the IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”. According to paragraph 5 IAS 8:

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

(a) was available when financial statements for those periods were authorised for issue; and

(b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.

Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud

Also, according to paragraph 41 IAS 8 financial statements do not comply with IFRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of an entity’s financial position, financial performance or cash flows. After that IAS 8 give us explanation how to correct material errors.

In general, the lack of attention to the correction of minor, unintentional errors can hardly be considered a shortcoming of IAS 8. After all, IFRS usually do not consider non-essential items at all. Moreover, IAS 8 in paragraph 8 even explicitly states that companies should not apply accounting policies if the impact of their application on the financial statements is insignificant. However, it strictly forbids making even minor deviations from IFRS or leaving them uncorrected in order to achieve a special presentation of the financial position, financial performance or cash flows of the entity.

NOTE. Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.

Let`s go further. What is intentional error? This category isn`t described in IFRS. But we have interesting thoughts about this issue from IAASA (Observations on materiality in financial reporting):

During the periodic financial reporting process, there is potential for the manipulation of the materiality concept in order to achieve a particular presentation of an entity`s financial position, financial performance or cash flows by intentionally leaving errors uncorrected on the grounds that they are not material. IFRS does not permit such intentional errors to remain uncorrected, even where they have been assessed by the entity as immaterial. Commonly quoted examples of where apparently immaterial errors can have material impact include where an error results in a reversal of a trend - for example, a loss being turned into a profit or vice versa - or where it impacts on ratios or other metrics used to evaluate, for example, debt covenant breaches. Moreover, the set-off of compensating error amounts does not transform material misstatements into immaterial misstatements, particularly where such items do not appear in the same line item or subtotal amount, or where they, on their own, would relate to transactions meriting separate disclosure

So, according to IAASA, if a company finds an error and classifies it as insignificant, but it leads to a change in the trend reflected in the reporting, it may indicate a significant impact on the reporting, and therefore needs to be corrected. Fascinating, isn`t it?

As you can see, it is often difficult to distinguish intentional errors from unintentional. At the same time, determining the significance of an error is complicated when it affects several accounting periods. And there are different methods to determinate it. For example, cumulative.

From all this we can draw the following conclusions:

• the method of assessing the significance of the error is important;
• the category of "intentional error" is rather vague, and therefore, the actual detection of an error and its non-correction may indicate the intent of action.

Also noteworthy here is paragraph 74 of IFRS Practice Statement 2 “Making Materiality Judgments”:

Immaterial errors, if not made intentionally to achieve a particular presentation, do not need to be corrected to ensure compliance with IFRS Standards. However, correcting all errors (including those that are not material) in the preparation of the financial statements lowers the risk that immaterial errors will accumulate over reporting periods and become material

So, firstly, if an error is found, the determination of its significance should be approached with extreme caution. Secondly, it is necessary to assess the cumulative impact of such an error on future periods. Accordingly, most mistakes, even those that seem insignificant at first glance, are best to be corrected. In addition, it should be remembered that the financial statements should in any case be relevant and reliable (see also paragraphs 2.13, 2.18 Conceptual Framework).

Next question: how to do it? As noted above, IAS 8 have requirements about correction of material errors. And paragraph 42 IAS 8 requires retrospective correction of such errors. Exception: it is not possible to determine either the effect on a specific period or the cumulative effect of the error.

In this regard, the practice has came to conclusion, that insignificant errors can be corrected in the current period through profit or loss with no restatement of prior period(s) financial statements.

By the way, American colleagues follow a similar approach. EY auditors, commenting on the process of correcting errors under US-GAAP, note:

When the error is immaterial to the prior period(s) financial statements and correcting the error in the current period is not material to the current period financial statements, the error is generally corrected in the current period with no restatement of prior period(s) financial statements

Let`s sum up. Immaterial errors can be corrected in the current period. But every situation needs a judgment.