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Restatements, Weaknesses Drop Again in 2009

Tammy Whitehouse | February 2, 2010

Restatements and material weaknesses took a sharp dive in 2009, but it’s not entirely clear whether that means companies are making fewer mistakes or just catching and reporting fewer mistakes.

In 2009, only 75 companies with markets capitalizations of at least $250 million restated their financial statements, according to data from Glass Lewis & Co. That’s fewer than half the 172 companies that restated in 2008—and even that was a steep drop from the 334 that restated in 2007. Glass Lewis said the 2009 figure represents the lowest restatement rate since 2001, when massive corporate frauds at Enron, WorldCom and others began a whirlwind of accounting clampdown and restatements.

The number of companies reporting material weaknesses also dropped considerably to 69 in 2009 from 193 in 2008 and 325 in 2007. Only 87 companies in 2009 received adverse opinions on internal controls from their external auditors, down from 202 in 2008 and 263 in 2007.

Lower numbers in restatements and material weaknesses could indicate companies are producer cleaner financial statements, but it could also mean they’re just not finding or reporting mistakes, Glass Lewis said. “Unfortunately, I don’t think there’s a definitive way to tell ahead of time whether companies and auditors are missing anything,” said Research Analyst Mark Grothe. “You have to wait and see if they discover and report any errors in the future that they should’ve known about today.”

Corporations and their auditors are operating under relaxed standards for assessing and auditing internal controls over financial reporting, with the earlier, more rigid Auditing Standard No. 2 replaced by guidance for management from the Securities and Exchange Commission and a more risk-based Auditing Standard No. 5.

“Obviously if the standards were still the same for internal-control audits, materiality thresholds and correcting errors, it would be easier to attribute the declines to better financial reporting,” said Grothe. “But the fact that all of these have been relaxed gives credibility to the argument that executives and auditors are just missing things.”

The Securities and Exchange Commission has pondered the meaning behind lower numbers of restatements and material weaknesses. “Observations from annual reviews of registrants' disclosures of material weaknesses make me wonder whether registrants and auditors are identifying and reporting all material weaknesses,” said Doug Besch, SEC professional accounting fellow, in a speech to the American Institute of Certified Public Accountants in December.

Glass Lewis also examined the rate of auditor turnover, which often is associated with accounting disputes that lead to restatements and material weakness disclosures in later periods. The firm said 62 companies changed auditors in 2009, down 33 percent from 2008. Big Four firms picked up a net of 16 new audit engagements, likely because the firms have more “bandwidth” to take in more work now that internal control audit work is maturing.

More key findings from the firm’s research:
• Expense recognition, mis-classifications, and taxes remained the most common error type.
• Last year, companies delayed 115 financial reports, down 58 percent from 2008.
• In the fifth year of Sarbanes-Oxley Section 404(b) audits, the 87 adverse opinions given by auditors represents a 78 percent decline from the first year.
• The percentage of companies with ineffective controls fell to 2 percent in 2009 from 6 percent in 2008.