Nobody’s perfect. In the sometimes-harum-scarum world of GAAP interpretation and booking accounting events, mistakes do happen. And just as you do with changes in estimates, the important point is to make sure that you correct any inadvertent mistakes in reporting accounting transactions on the financial statements in complete accordance with the way generally accepted accounting principles (GAAP) — and that you do so as soon as you discover those mistakes.
Wondering what the difference is between an inadvertent error and fraud? Errors aren’t deliberate. Fraud takes place when there’s a deliberate intent to mislead the users of the financial statements.
Following are the most prevalent errors:
Change in accounting principle from non-GAAP to GAAP: This is considered an error only because you’re going from non-GAAP to GAAP. For example, the company may switch from using the cash method of accounting to using the accrual method.
Math mistakes: These mistakes occur when the financial accountant, or the accounting software, just flat-out fails to record something correctly. As a good example, maybe you’re totaling a column of figures and you make a mistake adding them up; the mistake then affects some aspect of data entry into the accounting software system and flows through to the financial statements.
Bad-faith estimates: The company adopts an estimate, such as useful life, for an asset that, at the inception, is clearly unrealistic.
Incorrect recognition: The company doesn’t accrue or defer expenses and/or revenues appropriately. Improper presentation is another concern: In this case, you fail to show the transaction in the right way on the financial statement. For example, maybe you take an expense to the balance sheet instead of to the income statement.
Interpretation of facts: The accountant misuses or misinterprets currently available information. Figuring salvage value on an asset is an easy-to-understand example. Say that the best information available at the time for salvage value for a particular asset is that its worth at disposal will be $5,000. The financial accountant unilaterally decides not to use this figure, but uses $10,000 instead.
Inadvertent errors fall into three broad categories: math mistakes, improperly applied GAAP, and incorrect interpretation of facts available at the time the financial statements are issued.