Prior Period Adjustment, or PPA, is a method used to adjust and correct accounting mistakes that have been made in the past financial year.
In other words, PPA is used to correct non-fraudulent errors made mainly due to miscalculations and unrecorded transactions.
Such errors can commonly occur when employees and employers fail to report and calculate the payroll accurately, report the wrong time and date in the statements, and when the payroll administrator doesn’t correctly classify an employee.
When Do You Need a PPA?
PPA is widely used for two purposes:
To correct mistakes made in financial statements in the previous period determined in the current period, whether due to miscalculation or for not reporting specific payments in the payroll;
To make adjustments caused by the realization of income tax benefits from the operational losses of pre-acquired purchased subsidiaries.
The second situation is quite rare. Therefore, PPA is used mostly for the first scenario.
Besides, this method is applied only in cases of material error, that is, errors that are significant enough to impact the financial statements and, as a result, cause errors in financial decision-making.
Following are the mistakes that can make you resort to PPA:
Calculation and mathematical application errors;
Errors in applying accounting methods and policies;
Misuse of data when the financial statement was prepared;
Failing to record revenues or expenses;
Misinterpreting numbers and facts;
How Does PPA Work?
Necessary adjustments should be made to account for the mistakes in the prior financial statement or tax return as soon as you notice the issues to avoid penalties.
The prior years' financial statements that need corrections must be restated to carry out PPA. There are four ways to do it:
Adjusting the amounts of miscalculated assets and liabilities with the current accounting period.
Adjusting the current period retained earnings to change the carrying balance in the statement of retained earnings. This will allow you to show correctly done calculations in the prior statements which needed the adjustment.
Canceling employees’ previous payrolls and preparing them again with the proper date and time and necessary corrections to solve the material error.
For tax corrections of individual employees or the company as a whole, show the PPA as receipts or deductions in corporate profits.
How Should You Present a PPA?
There are three ways you can present PPA, depending on when the adjustments were made. These presentations of material error adjustments are as follows:
If you’re adjusting the prior period to your recent accounting period and there’s no gap between the time, the adjustment should impact the immediately prior period. In this case, the presentation should show the PPA as if there was never an error.
In case there’s a gap between the prior period and the current period, and you’re making adjustments for a prior period or a few of them, you should restate the gap to show the adjustment's impact on the current period.
To present the record of any PPA on the payroll, financial statements, or tax returns, and show the effect of the corrections on each line of the statements. In the end, you must show its overall effect on retained earnings.
What if the errors are immaterial? To avoid suspicion from investors and creditors about the PPA on your financial statements and tax returns, avoiding any adjustments of such amounts is best. Remember that you can only do this if your company’s financial worth is significant enough to count the error as immaterial.
How Can You Avoid a PPA?
You can do a few things to avoid any adjustment for a prior period error. For instance,
You should figure out the right accounting method for every financial statement you’re preparing, whether for regular payroll or payroll with bonuses and overtime payments.
You can send out reminders to your employees to fill in their timesheets and double-check everything to ensure they have put in the right information.
You should use good and correct payroll software for your company to ensure you don’t miss out on any amount that may lead to a PPA later.
You should revise all the statements, including deductions and accruals, prior to the payroll deadline. This way, you can detect errors and correct them accordingly.
You should take time to accommodate yourself with the policies around payrolls, and get familiar with the financial terms and how you should work with them.