Correction of prior period accounting errors in financial statements

Financial statements must be prepared in compliance with the Accounting Act and must contain statutory elements, such as data for the current and prior accounting periods. If a prior period accounting error is identified, the matter is resolved in compliance with accounting regulations and methodological guidelines. The current version of Decree No. 500/2002 Sb., implementing certain provisions of Act No. 563/1991 Sb., on Accounting, as amended, for businesses using double-entry accounting, as amended (“Decree”), stipulates the proper method for correcting errors for the accounting period starting on 1 January 2013. For many years, Czech accounting experts have criticised obsolete provisions of Czech accounting regulations, which required accounting for errors by means of extraordinary expenses and extraordinary income under Czech Accounting Standard No. 019 (para 3.10.5 and 4.7.3) . The amendment to the Decree describes this old concept as follows: “Item ‘A.IV.3 Other retained earnings/accumulated losses” contains differences arising from changes in accounting methods and a part of deferred tax under Section 59 (6). It also contains corrections of errors arising from incorrect accounting or the failure to account for expenses and income for prior accounting periods if material.” In this case, an error means an omission or incorrect accounting for or misstatement of an item (transaction) in financial statements, either in an incorrect amount or in an incorrect row.

Item A.IV.3 is applied in the following cases:

(a) Changes of accounting methods (such as the method of asset depreciation); (b) The first year of accounting for and reporting deferred tax when deferred tax is recognised in a given row that relates to a prior accounting period (it is basically a change of an accounting method); (c) Correction of material errors affecting expenses or revenues (such as arising from a failure to account for expenses or revenues or the incorrect carrying of expenses to assets or otherwise). The term materiality is not precisely defined and Czech accounting standards under Section 19 (6) of the Accounting Act only contain a general wording: “Information is considered material (important) if the failure to state or misstatement of the information could affect the judgement or decision-making of a person using the information”. The assessment of the materiality level of a relevant accounting item is the responsibility of the entity that should have the levels defined in its internal guidelines.

Correction of immaterial errors

If a prior period accounting error is classified by the entity as immaterial, the expense may be carried to profit/loss for the current period, to the same expense group as the one selected in the prior accounting period. However, this fact has an impact on the tax-deductibility of such expenses. Under Section 23 (3) (a) (4) of Act No. 586/1992 Sb., on Income Taxes (“ITA”), profit/loss is increased by items decreasing the profit/loss for the prior tax period under Section 23 (3) (c) (1) and (2) of the ITA in the tax period in which the error is corrected in the accounting and in which it affected the profit/loss. In addition, profit/loss is increased by the amount decreasing the profit/loss for the prior tax period under 23 (3) (c) (1) of ITA, in the tax period in which the error is corrected in the balance sheet. An immaterial error made in connection with an invoice for rent received in 2014 that related to 2013 can be accounted for as follows:
Text Amount in CZK Debit Credit
Invoice received for rent 12/2013 10,000 51x 32x

Corrections of material errors

If a prior accounting error is assessed as material, it must be reflected in the A.IV.3 item, as explained above. The accounting entry would then be made as follows:
Text Amount in CZK Debit Credit
Invoice received for rent 12/2013 10,000 42x 32x
Using the 42x account should have no impact on the profit/loss for the current period. The correction would be part of retained earnings in the “current accounting period” column. Subsequently, the A.IV.3 item must be thoroughly described in the notes to the financial statements. Nevertheless, accounting regulations do not define how comparative amounts reported in the financial statements should be corrected. This is now addressed by the National Accounting Council which is preparing a new interpretation and a clear definition of this issue.