Significant or not significant error? That is the question…

jelentős összegű hiba

A company can learn about various pieces of information during the year that affect the results of previous, closed financial years, be they errors discovered during self-revisions, or in a worse-case scenario, tax shortfalls found in a tax inspection along with the related penalties and interest. Companies have various tasks to perform here depending on whether the error or the impacts of the error are significant or not.

What constitutes an error? 

An error is considered to be any omission, mismanagement or misrepresentation of information in the financial statements of a business entity in one or more previous financial years, which are derived from failing to use or misusing information.

An error can also arise in connection with recognising, valuing, presenting or disclosing individual items in the financial statements.

These errors can be arithmetic mistakes, ignoring or misinterpreting facts, or the impacts of fraud.

What constitutes a significant and a not significant error? 

Companies record in their accounting policies what constitutes a significant and not significant error in relation to their own size. With due consideration of the threshold set forth in the accounting policies, under the Act on Accounting a significant error is considered to have been committed if the aggregate amount (whether positive or negative) of all errors and the impacts thereof for a given year – increasing or decreasing equity – exceeds 2 percent of the balance sheet total of the financial year under review, or HUF 1 million (approx. EUR 3,200), if 2 percent of the balance sheet total does not exceed HUF 1 million (approx. EUR 3,200).

What happens in the event of a significant error? 

In the event of a significant error, three-column financial statements must be prepared, which means that the changes affecting previous years must be presented for all items of the balance sheet and the income statement beside the previous year’s data, in a separate column, the “middle column”. In practice, the business events affecting the previous financial year must be recorded in the books in the reporting year in a manner enabling them to be distinguished from the reporting-year figures later on. In three-column financial statements, the amounts of errors and related impacts in the middle column affecting the previous year/years

  • contain the reporting-year column figures on the balance sheet page, if their inclusion in the financial statements in the reporting year is justified, but
  • do not contain the reporting-year column figures on the income statement page.

So in the case of a significant error, the reporting-year profit/loss does not contain the errors and their impacts affecting previous years, and therefore cannot be used as the tax base for corporate tax in the reporting year either.

The profit/loss after tax figure in the middle column will be included under retained earnings in the column containing the reporting-year figures, together with the profit/loss after tax and the retained earnings of the previous financial year.

An important control point when preparing a three-column balance sheet and income statement is that the total of the middle column and the reporting-year column of the income statement should tally with the balance sheet items of the general ledger statement for the reporting year.

Any significant error and its impacts must be presented in the supplementary notes per balance sheet and income statement item. If additional information is needed, explanations must be provided alongside the numbers.

What happens in the event of a non-significant error? 

With a non-significant error there is no need to prepare three-column financial statements. The impact of the error on the profit/loss is contained under the reporting-year data in the income statement, and so this data appears in the reporting year’s profit/loss before tax and is thus used as part of the corporate tax base for the reporting year. However, errors and the impact(s) thereof affecting previous years should still be treated separately from an accounting perspective, at least at general ledger level, so they can be retrieved and tracked at any time.

Thus if a company detects an error during the year that (also) affects previous, closed financial years, then before getting anxious about having to prepare three-column financial statements it should definitely be examined whether the error and its impacts qualify as significant or not, because this decision could save a lot of unnecessary work.

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