Financial restatements for public companies in 2014 suggest that financial reporting continues to get more accurate and more reliable, but nagging indicators of control lapses still persist and will likely keep regulators and the auditors busy for quite some time.
The latest report on financial restatements from Audit Analytics pegs the total number of restatements in 2014 among U.S. registrants at 831, down 4.2 percent from 867 the year before. That number has now floated somewhere in the mid-800s for the past five years. Various indicators of the seriousness of restatements also have remained low.
For example, a growing number of restatements are for immaterial errors. In 2014, 76 percent of restatements did not require notice to investors that financial statements were not reliable, a figure that has grown steadily since the big restatement wave of 2005 and 2006. In addition, the average number of issues to be addressed in a restatement remained level at 1.65, and the average number of days to be restated fell to 496, the first time to fall under 500 after the 2006 spike. Also important, the average income adjustment resulting from restatements in 2014 fell to $1.9 million, again the lowest figure since the 2006 spike.
“This is the most positive report we’ve seen in years,” says Trent Gazzaway, national managing partner of professional standards for Grant Thornton. “The severity of restatements is the lowest it’s been in years. Overall the quality of financial reporting is definitely increasing.”
Emre Carr, a director at Berkeley Research Group, says the overall trend for the past several years is reflected in the 2014 data. “2006 was the turning point for the severity of restatements, in numbers, in dollar amounts, and materiality,” he says. “The overall trend now is toward restatements that involve unintentional as opposed to intentional accounting problems. Clerical errors are more and more the norm. compared to violations that to some degree are intentional.”
2004 and 2005 were the years that most of Corporate America came into full contact with the Sarbanes-Oxley Act for the first time, including its exhaustive Section 404 assessment and audit of internal control over financial reporting. That led to the spike in restatements in 2005 and 2006, which eventually passed as companies developed stronger SOX 404 processes and controls.
“This is the most positive report we’ve seen in years. The severity of restatements is the lowest it’s been in years. Overall the quality of financial reporting is definitely increasing.”
Trent Gazzaway, National Managing Partner of Professional Standards, Grant Thornton
John May, a partner with PwC, says one important indicator in the 2014 restatement data is the drop in restatements for material errors among accelerated filers, which went from 77 in 2013 to 47 last year. “The report showed a nearly 40 percent drop in restatements where reliance on prior financial statements was withdrawn by … accelerated filers,” he says.
Despite all the good news, one indicator did not move in a positive direction: the total number of restatements among accelerated filers. Accelerated filers reported 171 restatements in 2010; that number has grown steadily each year to 308 in 2013, and 309 last year. Meanwhile, restatements among non-accelerated filers continued to taper from the 2006 spike of 904, down to only 358 in 2014.
“It’s hardly a gigantic increase for accelerated filers,” says Chris Wright, managing director for consulting firm Protiviti. “But it’s noteworthy in that it’s the only metric that moved up among many.”
That could be, he says, because the accounting problems behind many of the errors that lead to restatement correlate with the issues that the Securities and Exchange Commission raises most often in comment letters, and that the Public Company Accounting Oversight Board addresses often in audit inspections. The issues also represent some of the most complex areas of accounting rules, he says.
‘Finding a New Floor’
What are those issues? The most common cause for restatements in 2014, according to Audit Analytics, stemmed from the accounting for debt, quasi-debt, warrants, and equity security issues. A close second was problems with cash-flow classifications. Clustered behind those top two leaders, companies also reported problems with accounting for taxes; revenue recognition; accounting for liabilities, payables, reserves, and accrual estimates; and foreign, related-party, affiliate, and subsidiary issues.
RESTATEMENT STATS
In the chart below, Audit Analytics provides the average number of issues per restatement from 2007 through 2014.
The following table from Audit Analytics provides the average income adjustment per restatement by companies on Amex, NASDAQ, or NYSE from 2007 through 2014.
Source: Audit Analytics.
Larger, multinational companies are more likely to experience problems in those areas just by the nature and complexity of their operations and the focus on fraud and corrupt practices in certain parts of the world, Wright says. “When you think of the size, the breadth, the span of control characteristics of larger filers, that probably drove these restatements,” he says.
As such, it’s possible that financial reporting has hit a new normal in mistakes that can be expected, Wright says. “We may be finding a new floor in restatement activities,” he says.
Gazzaway agrees that such a theory is possible. “It’s hard to give a definitive answer, but it’s unrealistic to expect we will ever be at zero restatements,” he says. “It’s an extraordinarily complicated profession, and as business gets more complicated, the business of producing quality financial reports in a short time frame gets to be a bigger challenge. I don’t know what the ‘right number of restatements’ is. I know it’s not zero, but I do feel like we might be approaching some sense of equilibrium.”
Still high on the agenda at the SEC, however, is a focus on those immaterial restatements—the 76 percent of all restatements that were not foretold in a Form 8-K filing. “The SEC staff has been very interested in how companies think about their internal controls when immaterial errors are identified,” May says. “They are looking not just at what actually happened, but also more broadly at what could happen with a focus on the root cause of the deficiency and the actual and potential effect.”
Brian Croteau, deputy chief accountant at the SEC, has focused on the topic at accounting conferences the past few years. Revisions that are not material, but still represent mistakes, are troubling, he says. “In asking questions around that, it became clear in many situations that perhaps companies hadn’t identified the proper control deficiency to begin with,” he said at a recent regional conference of the Institute of Management Accountants. “In evaluating the severity of the deficiency, the company may have evaluated only the actual error and not the potential error that could have occurred or was reasonably possible.”
The PCAOB also places heavy emphasis on the proper audit of internal controls, a trend members of the PCAOB say has continued with the 2014 inspection cycle. Members and staff at the PCAOB have said they noted some improvements in 2014 inspections, which have not yet been reported in public inspection reports, but still see some need for auditors to get to a more precise level of assurance that controls are designed and operating effectively.
No comments yet