Final answer:
A prior period error is a mistake in financial statements from a previous reporting period, often corrected by restating prior period financials and adjusting opening balances in the period the error is discovered, without affecting the current income statement.
Step-by-step explanation:
A prior period error refers to an inaccuracy in the financial statements of a company that originates from a previous reporting period. Such errors could stem from mathematical mistakes, oversight or misuse of facts, fraud, or a misinterpretation of facts that were available at the time the financial statements were prepared.
To correct a prior period error, companies should retrospectively restate the comparative figures in the financial statements of the prior period(s) where the error occurred. The process typically involves:
- Identifying the error and the period it relates to.
- Adjusting the opening balances of assets, liabilities, and equity for the earliest period presented.
- Restating prior period financials to reflect the correction.
This correction is recognized in the period in which the error is discovered. The correction of the error does not affect the current period's income statement; instead, it is directly adjusted against retained earnings or other equity components as of the beginning of the first period presented.