Financial statement restatements by public companies declined in 2020 to their lowest level in 20 years, according to a recent study.
Audit Analytics’ annual financial restatements review released last month examined trends for public companies from 2001 through 2020. The analysis found 364 companies filed restatements in 2020, a record low number for the years included in the report.
Only 4.9 percent of public companies restated their previous financial statements in 2020, compared to 6.8 percent in 2019 and 17 percent at the highest point in 2006. The results continued the decline in restatements observed by Audit Analytics in each of the past six years.
Of the restatements analyzed, accelerated U.S. filers accounted for 31.3 percent—a decrease from 46 percent in 2019. Non-accelerated U.S. filers accounted for 53.3 percent of financial restatements in 2020, an increase from 36 percent in 2019 and the highest percentage since 2011. The remaining 15.4 percent of restatements were made by foreign issuers.
Some explanations for the decrease in overall restatements include improvement in the quality of financial reporting because of the implementation of internal control assessments and attestations, improvements in audit quality, and the higher level of restatements in the mid-2000s following the introduction of Sarbanes-Oxley reforms. There is also the potential more companies are determining errors are not material for restatement.
The report does not include the significant impact of special purpose acquisition company (SPAC) restatements in 2021, which Audit Analytics anticipates will result in a record number of restatements in the near future.
Restatement method: The study noted revision restatements, correcting errors by revising previous periods in the current year’s financial report, occurred three times more than reissuances of previous financial statements. There were 246 revision restatements by 227 companies in 2020, approximately 75 percent of all 2020 restatements, compared to 79 reissuance restatements by 73 companies. Both revision and reissuance restatements have shown a trend of general overall decline for the study period, with revision restatements having declined every year since 2014.
Restatement issues: The most frequent accounting area of restatement in 2020 was revenue recognition at 17.3 percent. This finding marks the third year in a row revenue recognition led restatements, which is consistent with the issuance of the new revenue recognition standard in 2018. Other frequent areas for restatement were debt and equity securities (14.3 percent), liabilities and accruals (12.6 percent), tax matters (12.1 percent), and general expenses (11 percent). Cash flow classification dropped out of the top five for the first time since 2008.
Impact on net income: The average negative impact of restatements on net income in 2020 reached $17.6 million, the fourth highest amount in the past 18 years. This finding comes after 2019 had the lowest average negative impact at $1.7 million.
The year 2020 had the highest proportion of restatements with negative impact on net income since 2011. The increase was attributed in part to six 2020 restatements that had larger negative impacts than the largest negative restatement in 2019. Further, 2020 had the lowest average amount of restatements with positive impact on net income in 18 years.
The study found the largest negative restatements of the past 10 years are relatively small in dollar amount compared with the largest ones in 2002-06.
Severity: The report looked at several statistics to evaluate the complexity of the restatements, with higher numbers suggesting greater severity. It noted the timing of companies issuing additional restated financial reports in the future would change the results.
- The average number of days to file a restatement in 2020 declined to approximately 40 days from 65 days in 2019. There had been year-over-year increases in the average days from 2016-19.
- The average number of days in the 2020 restatement period (447) stayed relatively flat compared with 2019 (451). The finding represents the fourth year of decline, with 739 as the highest number of days noted in 2005.
- The average number of issues per restatement was up slightly to 1.57 from 1.53 in 2019. The highest average noted in the report was 2.48, also in 2005.
Recent SEC staff speeches addressing restatements
Representatives from the Securities and Exchange Commission (SEC) commented on restatements and materiality at the AICPA & CIMA Conference on Current SEC and PCAOB developments in December.
In the conference keynote, Acting Chief Accountant Paul Munter of the SEC’s Office of the Chief Accountant discussed management’s process for determining whether an identified error in previously issued financial statements is material. The materiality assessment considers not just the quantitative but also the qualitative impacts on investors, but it becomes more difficult to use qualitative analysis to avoid restatements when an error is quantitatively significant.
Financial statements need to be restated and reissued when they are materially misstated and can no longer be relied on. If the error is not material to the prior financial statements, but the correction would be material to the current period, the error can be corrected in the current period comparative financial statements by restating prior period information and disclosing the error (a “little r restatement”).
According to Munter, although the total number of restatements by U.S.-based public companies has declined each year for the past six years, “little r restatements” as a percentage of total restatements rose to nearly 76 percent last year, up from about 35 percent in 2005.
Munter also noted the SEC’s rulemaking agenda includes recovery of erroneously awarded incentive-based compensation to current or former executive officers based on financial information that was restated. In October, the SEC issued a release that reopened the comment period for 2015 proposed rules that would require issuers on national securities exchanges to have policies for “clawing back” excess compensation in the three fiscal years before a restatement correcting a material accounting error and to disclose the policies.
Lindsay McCord, chief accountant at the SEC’s Division of Corporation Finance, reminded participants of the need to apply Staff Accounting Bulletin No. 99 on materiality to evaluate the need for “little r” versus “capital R” restatements. “Capital R” restatements can require amended disclosures in SEC filings about disclosure controls and procedures.