Companies experience a variety of financial transactions throughout the month. These include providing products or services to customers, using employee labor or purchasing inventory. Every financial transaction impacts the company's financial statements. At times, company employees miss recording a financial transaction in the period when it occurs. When a financial transaction is not recorded, the financial statements are misstated by the amount of that transaction.
Income Statement Transactions Not Recorded
Income statement transactions consist of revenue and expense transactions. If the company omits recording a revenue transaction, it reports incomplete revenues for the period and understates its net income. If the company omits recording an expense transaction, it reports incomplete expenses for the period and overstates the net income. If the accountant discovers the omission before the end of the period, she can record an entry to recognize the income or expense transaction.
Balance Sheet Transactions Not Recorded
Balance sheet transactions impact only assets, liabilities or equity accounts. If the company omits recording a balance sheet transaction, these accounts will be misstated. If the accountant discovers the error before the end of the period, he should record an entry to reverse the original entry and record the correct entry. If the accountant discovers the error after the period closes and the company publishes the financial statements, the accountant needs to make an entry when the omission is discovered. Prior period financial statements need to be restated to include impact the entry would've made if it had been recorded.
Some omitted entries impact both the income statement and the balance sheet. In some cases, these entries balance themselves out in the following period and are called counterbalancing. An example of an entry that counterbalances occurs when a company omits an entry to record wages expense incurred in one period to be paid the following period. The impact of that transaction would be realized and recorded in the following period when the wages are paid. The errors stated in the income statements for the two periods offset each other. Net income would be overstated in the first period and understated in the second period. The liabilities would be understated in the first period and correctly stated in the second period.
Omitted entries that impact both the income statement and balance sheet and do not counterbalance misstate the financial statements for both periods and require a correcting entry when discovered. If the error is discovered after the financial statements are created, the company needs to restate the financial statements from the date of the error forward.
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