In accounting, overstated describes a balance, a transaction or a disclosure recorded or reported above the amount that should have been recorded or reported. It names a direction rather than a cause: the reported figure is too high, whether that came from an amount posted above what the documentation supports, an entry posted to the wrong side, or a transaction recorded that should never have been recorded at all.
That direction sits inside a defined term. Under generally accepted auditing standards a misstatement is a difference between what a financial statement item reports and what the applicable financial reporting framework requires for it to be presented fairly (AU-C 450, Evaluation of Misstatements Identified During the Audit, .04), the same definition that governs understated. Overstated names the half of that difference where the reported figure is the larger one, and whether a given difference matters at all is a separate materiality judgment.
Which Side the Correcting Entry Lands On
An overstated account is brought down by posting to the side opposite the one its balance sits on: a credit for an overstated asset or expense, a debit for an overstated liability, equity or revenue, following the normal balance rule set out in debit vs credit. That is the mirror of the entry an understated account needs. The other side of the correction lands wherever the amount actually belonged, or reverses the transaction outright when nothing should have been recorded.
Say a supplier invoice for repairs was posted twice in December.
December as recorded
Repairs and maintenance expense 31,200
Accounts payable 9,700
Duplicate posting of one supplier invoice 2,400
Correcting entry
Debit Accounts payable 2,400
Credit Repairs and maintenance expense 2,400
December as corrected
Repairs and maintenance expense 28,800
Accounts payable 7,300Both accounts were high by the same amount, and one entry brings each back to where it belonged.
What an Overstatement Does to Pretax Income
Which way pretax income moves depends on which account carries the overstatement. Expenses come out on the way to pretax income, so an overstated expense leaves pretax income short by the same amount. Revenue goes in, so an overstated revenue leaves pretax income high by the same amount.
A balance sheet account moves pretax income only through whatever sits on the other side of its entry. An overstated prepaid asset that should have been charged to expense sits opposite an understated expense, so pretax income is high by that amount, while an overstated accrued liability sits opposite an overstated expense and leaves pretax income short. Two overstatements in the same set of statements can therefore push reported profit in opposite directions.
Overstatement Is the Existence and Occurrence Side
Which side an account is wrong on also decides how it gets tested. Overstatement is the existence and occurrence question, approached by starting from the recorded balance and working back to the documentation behind it, the direction worked through in vouching. Understatement is the completeness question.
An Overstatement Left Inside Issued Statements
An overstatement nobody corrects does not stay the size it started at. Securities and Exchange Commission staff work through a registrant holding an improper expense accrual, an overstated liability of $100 built up over 5 years at $20 per year. They then set out the two techniques practice most commonly uses to size it: the rollover approach, which measures the error originating in the current year income statement, and the iron curtain approach, which measures the misstatement sitting in the balance sheet at the end of the current year whatever year it arose in (SEC, Staff Accounting Bulletin No. 108). The staff position is that neither one on its own is enough, and that registrants must quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements.
The practical consequence is the one the staff spells out. Correcting the whole $100 in the current year fixes the $20 that arose this year and the $80 that carried over from earlier ones, and in doing so misstates the current year income statement by $80. If that $80 understatement of current year expense is material, the prior year statements are corrected even though the error was and remains immaterial to those prior years, and correcting prior year statements for immaterial errors does not require previously filed reports to be amended (SEC, Staff Accounting Bulletin No. 108). Where a separate analysis shows the prior year statements were materially misstated, the bulletin sends the registrant to restate them under the standard it names, FASB Statement 154, Accounting Changes and Error Corrections, at paragraph 25 (SEC, Staff Accounting Bulletin No. 108).
Those are staff views addressed to SEC registrants, so a private client’s books are not governed by them. The reasoning still travels, because a small overstatement carried forward year after year is a private company problem too, and the year it finally gets cleared is the year the income statement takes the hit.
Common Questions
In accounting, it means a reported figure sits above the amount that should have been reported, whatever the cause.
In ordinary English, exaggerated, and that is the sense the word usually carries away from a ledger. In accounting only an amount, a transaction or a disclosure is overstated, and the word says the figure is higher than it should be rather than that a claim was put too strongly.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can put a block of its own closing work through a trial task and have its own reviewer grade the entries that come back.
