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Financial Reporting and the Law

Recent restatement studies released by the Center for Audit Quality (CAQ) and Audit Analytics show that an increasing percentage of restatements are filed by companies that do not disclose that prior financial statements are not reliable and an increasing percentage of restatements are being filed by accelerated filers. The most frequent reasons for the restatements appear to relate to complex accounting standards or highly judgmental accounting issues.

The FASB has projects related to some of these accounting issues. A proposed accounting standard update addresses whether a hybrid financial instrument issued as a share is more akin to debt or equity. The FASB’s simplification project may facilitate inventory measurement and accounting for goodwill, derivatives and hedging, and pensions. In addition, the FASB may provide further guidance on cash-flow statement classification issues. Another issue—revenue recognition—may be more judgmental in the future because of a new accounting standard. In addition, although the income tax accounting standard is extremely complex and challenging to implement, a recent Financial Accounting Foundation post-implementation review of that standard did not recommend any standard-setting changes, a conclusion with which some disagree.

Some of the restatement studies’ conclusions include the following:

  • Decreasing Number of Total Restatements: Although the numbers reported by CAQ and Audit Analytics vary because of differences in methodologies, both report decreases in restatements from a high in 2006 of 1,784 (CAQ) and 1,329 (Audit Analytics) to 738 (CAQ) and 567 (Audit Analytics) in 2012 and 564 in 2013 (Audit Analytics). Nevertheless, Audit Analytics reports an increase in the percentage of restatements that did not affect income reported by listed companies, from 37% in 2011 to 53% in 2013, perhaps in part because of SEC comments requiring restatements of footnotes reporting subsidiary guarantor cash flows.
  • Decreasing Number of Material Restatements: Since 2010, a decreasing percentage of restatements have been filed by companies that first reported on Form 8-K under Item 4.02 that prior financial statements should no longer be relied upon. Restatements disclosed pursuant to Item 4.02 were reported by between approximately 42% and 46% of the restating companies in 2010 and between 34% and 35% in 2012, and Audit Analytics reports that approximately 31% of the restatements disclosed in 2013 were first reported pursuant to Item 4.02.
  • Increasing Number of Restatements by Accelerated Filers: Audit Analytics reports that the number of restatements by accelerated filers increased from 157 in 2010 to 290 in 2013. In 2010, 59 of the 157 restatements were disclosed pursuant to Item 4.02. In subsequent years, these numbers were 73 of 210 (2011), 62 of 282 (2012), and 74 of 290 (2013).
  • Most Frequent Accounting Issues Causing Restatements: CAQ reports that, during the 10-year period ending 2012, the issues that were restated more than 10% of the time were accruals, reserves, and estimates (30% of all the issues restated); financing issues (23%); cash flow and other financial statement presentation issues (23%); revenue recognition (14%); stock compensation (13%); taxes (11%); and depreciation, capitalization, and amortization (10%). Audit Analytics reports that, in 2013, the most common accounting issues that were restated were accruals, reserves, and estimates (16.8%); financing issues (14%); cash flow classification (12.8%); revenue recognition (8.5%); and taxes (7.4%).
  • Material Weakness Disclosure Prior to Restatement: CAQ reports that, out of 861 Item 4.02 annual restatements that were preceded by reports on internal control over financial reporting (ICFR), 22% of the reports disclosed a material weakness in ICFR.