Effect of Corrections on Profit
When errors are corrected, some affect the net profit and others affect only the statement of financial position. Only errors involving a revenue or expense account change net profit. Errors involving only assets, liabilities or equity do not change profit but change balances in the statement of financial position.
Key idea
Revenue understated → add to profit. Expense understated / omitted → subtract from profit. Revenue overstated → subtract. Expense overstated → add.
Statement of Corrected Profit
After the errors are found, a statement of corrected net profit is prepared starting from the draft profit, then adding or subtracting the effect of each error.
A Worked Example
A business has a draft net profit of RM12,000. These errors are then found:
- Sales undercast by RM500 (revenue understated) → +500
- Rent expense of RM300 completely omitted → −300
- Purchases overcast by RM200 (expense overstated) → +200
Example
Corrected profit = RM12,000 + RM500 − RM300 + RM200 = RM12,400. Correcting an omitted debtor (an asset) does not change profit but increases current assets in the statement of financial position.
Errors That Touch the Statement of Financial Position
Some errors do not change profit but change balances in the statement of financial position. Examples are an omitted debtor or creditor, an asset shown at the wrong amount, or unrecorded drawings. When correcting them, adjust only the asset or liability figure concerned without touching profit.
Note too that an error in closing inventory has a double effect: overstated closing inventory raises both gross profit and current assets at the same time. So each correction must be judged on whether it touches profit, the statement of financial position, or both before the final figures are recomputed. For example, correcting an omitted depreciation charge increases expenses (lowering profit) and at the same time reduces the book value of the asset in the statement of financial position.
Remember
Ask: does the error touch a revenue or expense account? If yes, it changes profit. If it touches only assets/liabilities, profit is unchanged.