CPA Quiz: Correct Prior Period Errors
14 questions · exam conditions
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Correct Prior Period ErrorsQuestion 1 of 14

A for-profit construction contractor discovered in 2026 that in 2025 it recorded $350,000 of customer deposits as revenue upon receipt rather than as a contract liability. The error caused 2025 revenues and retained earnings to be overstated and liabilities to be understated; the deposits remained unearned at December 31, 2025. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, how should the prior period error be corrected in accordance with GAAP?

Correct prospectively in 2026 by reducing 2026 revenue $350,000 and increasing contract liabilities $350,000; no restatement is permitted for revenue errors
Restate 2025 by decreasing revenue $350,000 and increasing contract liabilities $350,000, adjust 2026 beginning retained earnings for the after-tax effect, and disclose the nature of the error and the impact on each financial statement line item and EPS for each period presented
Record a cumulative-effect adjustment to 2026 revenue (decrease) $350,000 with an offsetting increase to contract liabilities; do not adjust retained earnings
Reclassify the $350,000 within equity as restricted retained earnings at December 31, 2025 because deposits are not liabilities under GAAP
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CPA Quiz

CPA Quiz: Correct Prior Period Errors

Practice Correct Prior Period Errors in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Correct Prior Period Errors, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

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Question 1

A for-profit construction contractor discovered in 2026 that in 2025 it recorded $350,000 of customer deposits as revenue upon receipt rather than as a contract liability. The error caused 2025 revenues and retained earnings to be overstated and liabilities to be understated; the deposits remained unearned at December 31, 2025. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, how should the prior period error be corrected in accordance with GAAP?

  1. Correct prospectively in 2026 by reducing 2026 revenue $350,000 and increasing contract liabilities $350,000; no restatement is permitted for revenue errors
  2. Restate 2025 by decreasing revenue $350,000 and increasing contract liabilities $350,000, adjust 2026 beginning retained earnings for the after-tax effect, and disclose the nature of the error and the impact on each financial statement line item and EPS for each period presented (correct answer)
  3. Record a cumulative-effect adjustment to 2026 revenue (decrease) $350,000 with an offsetting increase to contract liabilities; do not adjust retained earnings
  4. Reclassify the $350,000 within equity as restricted retained earnings at December 31, 2025 because deposits are not liabilities under GAAP
Explanation: Under FASB ASC 606-10-25-1 and ASC 250-10-45-23, customer deposits must be recorded as contract liabilities until the related performance obligations are satisfied, and prior period errors require retrospective restatement. The $350,000 of customer deposits incorrectly recorded as revenue in 2025 overstated revenues and retained earnings while understating liabilities. The correct treatment requires restating 2025 by decreasing revenue $350,000 and increasing contract liabilities $350,000, adjusting 2026 beginning retained earnings for the after-tax effect, and disclosing the nature of the error and its impact on each financial statement line item and EPS for each period presented. Option A is incorrect because it corrects prospectively when retrospective restatement is required for material errors. Option C is incorrect because it records the adjustment through 2026 revenue rather than restating 2025. Option D is incorrect because customer deposits are liabilities under GAAP, not restricted equity. The professional framework for revenue recognition requires careful assessment of when control transfers to customers, with unearned amounts reported as contract liabilities until performance obligations are satisfied.

Question 2

A for-profit manufacturer discovered in 2026 that depreciation on equipment was calculated using a 10-year life instead of the correct 5-year life beginning in 2025. The equipment cost $1,000,000, has no salvage value, and was placed in service on January 1, 2025; straight-line depreciation is used. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, what journal entry should be made to rectify the prior period error (ignoring income taxes)?

  1. Dr Depreciation expense $100,000; Cr Accumulated depreciation $100,000 (to correct 2026 depreciation only)
  2. Dr Retained earnings $100,000; Cr Accumulated depreciation $100,000 (to record the cumulative 2025 understatement of depreciation) (correct answer)
  3. Dr Retained earnings $200,000; Cr Accumulated depreciation $200,000 (to record the cumulative 2025–2026 understatement of depreciation)
  4. Dr Accumulated depreciation $100,000; Cr Retained earnings $100,000 (to reverse excess depreciation recorded in 2025)
Explanation: Under FASB ASC 250-10-45-23, the correction of a depreciation error requires retrospective restatement with the cumulative effect recorded as an adjustment to beginning retained earnings. The equipment should have been depreciated at 200,000peryear(200,000 per year (1,000,000 ÷ 5 years) but was only depreciated at 100,000peryear(100,000 per year (1,000,000 ÷ 10 years), resulting in $100,000 of understated depreciation expense and overstated net income in 2025. The correct journal entry debits retained earnings $100,000 and credits accumulated depreciation 100,000torecordthecumulativeunderstatementofdepreciationthroughDecember31,2025.OptionAisincorrectbecauseitonlycorrects2026depreciationprospectivelyratherthancorrectingthepriorperioderror.OptionCisincorrectbecauseitrecordstwoyearsofcatch−updepreciation(100,000 to record the cumulative understatement of depreciation through December 31, 2025. Option A is incorrect because it only corrects 2026 depreciation prospectively rather than correcting the prior period error. Option C is incorrect because it records two years of catch-up depreciation (200,000) when only one year (2025) requires correction through retained earnings. Option D is incorrect because it reverses the direction of the adjustment - depreciation was understated, not overstated. The professional framework requires calculating the cumulative effect of the error through the beginning of the current period and recording that amount as an adjustment to beginning retained earnings.

Question 3

A for-profit software company discovered in 2026 that it recognized $400,000 of revenue in December 2025 for a one-year noncancellable support contract that began January 1, 2026; the entire amount should have been recorded as a contract liability (deferred revenue) at December 31, 2025. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, what journal entry should be made to rectify the prior period error on January 1, 2026 (ignoring income taxes)?

  1. Dr Cash $400,000; Cr Deferred revenue $400,000 (to reclassify the cash receipt to a liability)
  2. Dr Retained earnings $400,000; Cr Deferred revenue $400,000 (to reverse the prior-period revenue and record the contract liability) (correct answer)
  3. Dr Revenue $400,000; Cr Deferred revenue $400,000 (to reverse 2025 revenue in 2026 income)
  4. Dr Deferred revenue $400,000; Cr Retained earnings $400,000 (to increase equity for the contract obligation)
Explanation: Under FASB ASC 606-10-25-1, revenue is recognized when performance obligations are satisfied, which for a one-year support contract beginning January 1, 2026, means no revenue should have been recognized in 2025. The $400,000 incorrectly recognized as revenue in December 2025 overstated 2025 net income and retained earnings while understating contract liabilities. The correct journal entry on January 1, 2026, debits retained earnings $400,000 and credits deferred revenue (contract liability) $400,000 to reverse the prior-period revenue recognition error and establish the proper liability. Option A is incorrect because it attempts to reclassify cash rather than correcting the revenue recognition error. Option C is incorrect because it records the reversal through 2026 income rather than as a prior period adjustment to retained earnings. Option D is incorrect because it reverses the debit and credit, which would increase rather than decrease equity. The professional framework for revenue recognition under ASC 606 requires careful analysis of when performance obligations are satisfied, with contract liabilities recorded for cash received before performance.

Question 4

A for-profit retailer discovered in 2026 that its 2025 year-end inventory count omitted $250,000 of goods on hand, causing 2025 ending inventory and total assets to be understated and 2025 cost of goods sold (COGS) to be overstated. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250 (Accounting Changes and Error Corrections), what is the correct adjustment to the financial statements for the error identified?

  1. Record a 2026 adjustment to COGS (decrease) and inventory (increase) for $250,000 with no restatement because the error relates to a prior year already issued
  2. Restate 2025 comparative amounts by increasing ending inventory and total assets $250,000, decreasing COGS $250,000, and adjust 2026 beginning retained earnings for the after-tax effect, with disclosure of the nature and effect of the correction (correct answer)
  3. Restate only the 2026 statements by increasing beginning inventory $250,000 and decreasing 2026 COGS $250,000; do not adjust 2025 comparative statements
  4. Recognize the $250,000 as a prior-period adjustment directly to retained earnings in 2026 without restating 2025 and without disclosure because it is an inventory count difference
Explanation: Under FASB ASC 250-10-45-23, prior period errors must be corrected through retrospective restatement of all prior periods presented. The $250,000 inventory understatement in 2025 caused ending inventory and total assets to be understated by $250,000 and cost of goods sold to be overstated by $250,000, resulting in understated net income. The correct treatment requires restating the 2025 comparative financial statements by increasing ending inventory and total assets by $250,000, decreasing COGS by $250,000, and adjusting 2026 beginning retained earnings for the after-tax effect of the increased 2025 net income. Option A is incorrect because ASC 250 prohibits correcting prior period errors through current period adjustments when comparative statements are presented. Option C is incorrect because it fails to restate the 2025 comparative statements as required by ASC 250-10-45-23. Option D is incorrect because it neither restates prior periods nor provides the required disclosures under ASC 250-10-50-7. The professional framework for error corrections requires retrospective restatement of all periods presented, adjustment of beginning retained earnings for the cumulative effect, and comprehensive disclosure of the nature and impact of the error.

Question 5

A for-profit wholesaler discovered in 2026 that in 2025 it improperly expensed $500,000 of equipment purchases as repairs and maintenance. The equipment has a 5-year life, no salvage value, and was placed in service on July 1, 2025; straight-line depreciation is used. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, what is the correct adjustment to the financial statements for the error identified (ignoring income taxes)?

  1. Restate 2025 by increasing property, plant, and equipment $500,000, decreasing repairs expense $500,000, and recognizing 2025 depreciation expense of $50,000; increase 2025 net income by $450,000 and adjust 2026 beginning retained earnings accordingly, with required disclosures (correct answer)
  2. Record a 2026 adjustment by capitalizing the equipment at $500,000 and recording 2026 depreciation only; no restatement is permitted because the 2025 statements were issued
  3. Restate 2025 by increasing PP&E $500,000 and decreasing repairs expense $500,000; do not record any depreciation until 2026 because the asset was not previously recognized
  4. Restate 2025 by decreasing PP&E $500,000 and increasing repairs expense $500,000 because expensing is more conservative; disclose the reclassification only
Explanation: Under FASB ASC 360-10-35-4, equipment must be capitalized and depreciated over its useful life rather than expensed immediately. The $500,000 of equipment incorrectly expensed as repairs in 2025 should have been capitalized and depreciated for six months (July 1 - December 31, 2025), resulting in depreciation expense of 50,000(50,000 (500,000 ÷ 5 years × 6/12 months). The correct treatment requires restating 2025 by increasing PP&E $500,000, decreasing repairs expense $500,000, and recognizing depreciation expense of $50,000, resulting in a net increase to 2025 income of $450,000 with corresponding adjustments to 2026 beginning retained earnings. Option B is incorrect because it prohibits restatement when ASC 250 actually requires it for material errors. Option C is incorrect because it fails to record 2025 depreciation expense for the six months the asset was in service. Option D is incorrect because it reverses the proper treatment and suggests expensing is preferable when capitalization is required under GAAP. The professional framework for fixed asset accounting requires capitalizing all costs necessary to prepare an asset for its intended use, with systematic depreciation over the asset's useful life.

Question 6

A for-profit company with a foreign subsidiary discovered in 2026 that in 2025 it incorrectly recorded the foreign currency translation adjustment (CTA) from translating the subsidiary's financial statements as a gain in net income instead of in other comprehensive income (OCI) within accumulated other comprehensive income (AOCI). The misstatement increased 2025 net income by $120,000 and increased AOCI by $0. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250 and ASC 830 (Foreign Currency Matters), what is the correct adjustment to the financial statements for the error identified (ignoring income taxes)?

  1. Record the $120,000 as other income in 2026 and reclassify it to OCI over time; no restatement is needed because CTA is noncash
  2. Restate 2025 by decreasing net income $120,000 and increasing OCI (AOCI) $120,000, with corresponding adjustment to 2026 beginning retained earnings and required error-correction disclosures (correct answer)
  3. Restate 2025 by increasing net income $120,000 and decreasing OCI $120,000 because translation adjustments are realized through earnings
  4. Correct prospectively by reclassifying $120,000 from retained earnings to AOCI in 2026 without restating 2025 and without disclosing quantitative impacts
Explanation: Under FASB ASC 830-30-45-12, foreign currency translation adjustments must be reported in other comprehensive income (OCI) as a component of accumulated other comprehensive income (AOCI), not in net income. The $120,000 translation adjustment incorrectly recorded in 2025 net income overstated earnings and understated OCI by the same amount. The correct treatment requires restating 2025 by decreasing net income $120,000 and increasing OCI $120,000, with a corresponding adjustment to 2026 beginning retained earnings to reflect the lower 2025 net income, along with required error-correction disclosures under ASC 250-10-50-7. Option A is incorrect because it suggests recording the correction in 2026 income rather than restating 2025. Option C is incorrect because it reverses the direction of the correction - translation adjustments should move from net income to OCI, not vice versa. Option D is incorrect because it corrects prospectively without restatement and fails to provide required quantitative disclosures. The professional framework for foreign currency translation requires careful segregation of translation adjustments in OCI from transaction gains and losses that flow through net income.

Question 7

A for-profit service company discovered in 2026 that $90,000 of 2025 advertising costs were incorrectly classified as prepaid expense at December 31, 2025 even though the advertising had already run in 2025. As a result, 2025 assets were overstated and 2025 operating expenses were understated. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, what journal entry should be made to rectify the prior period error on January 1, 2026 (ignoring income taxes)?

  1. Dr Advertising expense $90,000; Cr Prepaid expense $90,000 (to correct 2026 expense recognition)
  2. Dr Retained earnings $90,000; Cr Prepaid expense $90,000 (to reverse the overstated asset and reduce equity for the prior-period expense omission) (correct answer)
  3. Dr Prepaid expense $90,000; Cr Retained earnings $90,000 (to record the asset that should have been recognized)
  4. Dr Advertising expense $90,000; Cr Retained earnings $90,000 (to recognize the expense directly in equity)
Explanation: Under FASB ASC 720-35-25-1, advertising costs are generally expensed as incurred or when the advertising first takes place. The $90,000 of advertising costs that ran in 2025 but were incorrectly classified as prepaid expense at December 31, 2025, resulted in overstated assets and understated 2025 operating expenses. The correct journal entry on January 1, 2026, debits retained earnings $90,000 and credits prepaid expense $90,000 to reverse the overstated asset and reduce equity for the prior-period expense omission. Option A is incorrect because it records the adjustment through 2026 expense rather than as a prior period adjustment to retained earnings. Option C is incorrect because it increases rather than decreases the prepaid expense asset. Option D is incorrect because it fails to reverse the prepaid expense asset that was incorrectly recorded. The professional framework for advertising costs requires immediate expensing when the advertising takes place, with very limited exceptions for direct-response advertising that meets specific capitalization criteria.

Question 8

A for-profit technology company discovered in 2026 that $600,000 of 2025 research and development (R&D) costs were incorrectly capitalized as an intangible asset and amortized over 3 years, instead of being expensed as incurred. At December 31, 2025, the balance sheet included an intangible asset of $600,000 related to this error; no amortization was recorded in 2025. The 2025 financial statements were issued and are presented comparatively with 2026. Under FASB ASC 250, which financial statement line item needs adjustment to correct the error?

  1. Increase 2026 operating expenses and decrease 2026 net income by $600,000; do not restate 2025 because the costs were incurred in 2025
  2. Decrease 2025 intangible assets by $600,000 and decrease 2025 retained earnings by $600,000 through retrospective restatement of 2025 comparative statements (ignoring taxes), with appropriate error-correction disclosures (correct answer)
  3. Reclassify the $600,000 from intangible assets to prepaid expenses at December 31, 2025 because the benefit period is short term
  4. Adjust only the statement of cash flows by reclassifying the $600,000 from investing to operating; no balance sheet or income statement changes are required
Explanation: Under FASB ASC 730-10-25-1, research and development costs must be expensed as incurred and cannot be capitalized as intangible assets. The $600,000 of R&D costs incorrectly capitalized in 2025 resulted in overstated assets and understated expenses, thereby overstating 2025 net income and retained earnings. The correct treatment requires retrospectively restating the 2025 comparative financial statements by decreasing intangible assets by $600,000 and decreasing retained earnings by $600,000 (the after-tax effect would be considered in practice), with appropriate error-correction disclosures under ASC 250-10-50-7. Option A is incorrect because it treats the correction as a current period expense rather than restating the prior period. Option C is incorrect because R&D costs cannot be reclassified as prepaid expenses - they must be expensed immediately under ASC 730. Option D is incorrect because it only addresses cash flow classification without correcting the fundamental error of capitalizing R&D costs. The professional framework for R&D accounting requires immediate expensing of all research and development costs as incurred, with no exceptions for capitalization.

Question 9

During 2024, Coastal Industries discovered that inventory costing $80,000 was incorrectly included in cost of goods sold in 2022 instead of 2023. The error was discovered after the 2023 financial statements were issued. Coastal's tax rate is 30%. How should this error correction be reported in Coastal's 2024 financial statements?

  1. Increase 2024 beginning retained earnings by $56,000 and decrease 2024 cost of goods sold by $80,000
  2. Record a prior period adjustment increasing beginning retained earnings by $56,000 with corresponding disclosures (correct answer)
  3. Report as a change in accounting estimate and adjust 2024 cost of goods sold by $80,000
  4. Record a prior period adjustment increasing beginning retained earnings by $80,000 with corresponding tax adjustments
Explanation: This is a prior period error that requires retrospective restatement. The error caused 2022 COGS to be overstated and 2023 COGS to be understated by $80,000. Since 2023 statements were issued, a prior period adjustment to beginning retained earnings is required. The net after-tax effect is $80,000 × (1 - 0.30) = $56,000 increase to retained earnings. Choice A incorrectly adjusts 2024 COGS. Choice C mischaracterizes this as an estimate change. Choice D ignores the tax effect.

Question 10

Arctic Industries uses the percentage-of-completion method for long-term contracts. During a 2024 audit, it was discovered that a contract's percentage of completion was incorrectly calculated in 2022 and 2023. The correct calculations show:

2022: Should have recognized $400,000 revenue (actually recorded $300,000) 2023: Should have recognized additional $250,000 revenue (actually recorded $350,000)

Total contract value is $800,000. Costs are 70% of revenues recognized.

What prior period adjustment should Arctic make to beginning retained earnings for 2024 to correct these errors?

  1. No adjustment needed since the errors offset over the contract period (correct answer)
  2. Increase retained earnings by $100,000 for the 2022 understatement
  3. Decrease retained earnings by $100,000 for the 2023 overstatement
  4. No net adjustment to retained earnings, but reclassify between revenue and cost accounts
Explanation: 2022 error: Revenue understated by 100,000(100,000 (400,000 - $300,000). 2023 error: Revenue overstated by 100,000(100,000 (350,000 - $250,000). The cumulative effect at 1/1/24 is zero because the errors exactly offset. While individual years were misstated, the cumulative revenue recognition through 12/31/23 totals $650,000 under both the incorrect and correct methods. Choice B only considers 2022. Choice C only considers 2023. Choice D incorrectly suggests reclassification when no adjustment is needed.

Question 11

In March 2024, Riverside Company discovered that its 2022 year-end inventory was overstated by $75,000 due to inclusion of goods shipped FOB destination that were in transit at year-end. The 2023 year-end inventory was correctly stated. Riverside's gross margin is 40% and the tax rate is 30%. What is the cumulative effect of this error on retained earnings as of December 31, 2023?

  1. $52,500 overstatement of retained earnings
  2. $31,500 overstatement of retained earnings
  3. $22,500 overstatement of retained earnings
  4. $0 because the error self-corrected in 2023 (correct answer)
Explanation: Inventory errors that affect only one period's ending inventory will self-correct in the following period. The 2022 overstatement of $75,000 caused 2022 COGS to be understated and net income overstated. However, this same overstatement caused 2023 beginning inventory to be overstated, making 2023 COGS overstated and net income understated by the same amount. By 12/31/23, the error has completely self-corrected. Choices A, B, and C incorrectly assume the error persists beyond the two-year cycle.

Question 12

In January 2024, Sunset Corporation discovered that a $60,000 insurance premium paid in December 2022 for coverage from January 2023 through December 2024 was incorrectly recorded as insurance expense in 2022. The 2023 financial statements have been issued. How should Sunset correct this error in its 2024 financial statements?

  1. Record a $30,000 increase to beginning retained earnings and a $30,000 prepaid insurance asset (correct answer)
  2. Record a $60,000 increase to beginning retained earnings and recognize $30,000 insurance expense in 2024
  3. Record a $45,000 increase to beginning retained earnings and a $15,000 prepaid insurance asset
  4. Record a $30,000 increase to beginning retained earnings and recognize $60,000 insurance expense over 2024
Explanation: The $60,000 should have been recorded as prepaid insurance in 2022, with $30,000 expensed in 2023 and $30,000 remaining for 2024. Since it was fully expensed in 2022, 2022 expenses were overstated by $60,000 and 2023 expenses were understated by $30,000. The net effect on retained earnings at 1/1/24 is 30,000(30,000 (60,000 - $30,000). At 1/1/24, there should be $30,000 in prepaid insurance. Choice B overstates the retained earnings adjustment. Choice C incorrectly calculates the amounts. Choice D misallocates the expense recognition.

Question 13

Mountain Corp discovered in 2024 that research and development costs of $150,000 incurred in 2022 were incorrectly capitalized as an intangible asset and being amortized over 10 years. No impairment has occurred. The error was discovered after 2023 statements were issued. Ignoring tax effects, what should be the balance of the intangible asset account after correcting this error in 2024?

  1. $120,000 representing the unamortized balance
  2. $135,000 representing costs less accumulated amortization
  3. $0 because R&D costs should be expensed when incurred (correct answer)
  4. $150,000 representing the original capitalized amount
Explanation: Under US GAAP, research and development costs must generally be expensed when incurred and cannot be capitalized as intangible assets. The entire $150,000 should have been expensed in 2022. The error correction requires removing the entire intangible asset balance and adjusting retained earnings for the cumulative effect. The asset should show a $0 balance after correction. Choice A incorrectly suggests partial amortization is appropriate. Choice B makes the same error. Choice D ignores the requirement to correct the error.

Question 14

Delta Corporation discovered in 2024 that it failed to record the following accruals at December 31, 2022: • Accrued wages payable: $40,000 • Accrued interest payable on bonds: $15,000 • Accrued rent receivable: $8,000

These items were properly recorded when cash was paid or received in 2023. Delta's tax rate is 25%.

What adjustment should Delta make to its January 1, 2024, retained earnings to correct these errors?

  1. Decrease retained earnings by $35,250 after considering tax effects
  2. Decrease retained earnings by $47,000 representing the net cash impact
  3. No adjustment needed since the errors corrected in 2023 (correct answer)
  4. Decrease retained earnings by $47,000 after considering all tax effects
Explanation: These accrual errors self-corrected during 2023. The failure to accrue at 12/31/22 understated 2022 expenses by 55,000(55,000 (40,000 + $15,000) and understated 2022 revenue by $8,000, for a net understatement of expenses of $47,000. However, when these amounts were recorded as expenses/revenue in 2023 (when cash was paid/received), 2023 expenses were overstated by the same $47,000 net amount. By 1/1/24, the cumulative effect is zero. Choices A, B, and D incorrectly assume an adjustment is needed.