Financial restatements continued their downward march in 2008, giving further credence to the theory that the Sarbanes-Oxley Act is improving corporate reporting as was intended.

According to a recent analysis by Audit Analytics, 869 companies restated their financial statements in 2008, a whopping 31.4 percent lower than the 1,235 restatements in 2007. Indeed, last year’s numbers are the lowest since 2003—the final year before SOX fully went into effect at large companies and forced a rising tide of restatements from 2004 to 2006.

Restatements are also taking a smaller bite out of profits. The typical hit to net income for a company restating financials last year was only $6.1 million, compared to $7.4 million in 2007 and $20 million in both 2006 and 2005. Restatements also took less time to file and cited fewer accounting problems.


“Not only is the number smaller, but the number we have is just not as severe,” says Don Whalen, director of research for Audit Analytics. “The issues driving restatements are going down.”

The continued improvement suggests that companies have improved their internal control over financial reporting, says Joey Borson, senior analyst at the Controllers Leadership Roundtable. “Companies … have been able to focus their attention on a smaller number of more impactful controls, so they’re able to catch errors earlier, before the financial statement phase,” he says.

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Borson’s views reflect much conventional wisdom about SOX compliance. Large companies first had to comply with Section 404 of the law—assessing their internal controls, finding weaknesses, and fixing them—in 2004. When they did, legions of companies discovered errors or weaknesses, and restatements soared to more than 1,800 by 2006. As companies gained a better understanding of their internal control systems and improved them, restatements subsequently began to fall.

It’s also possible that attitudinal shifts at the Securities and Exchange Commission are also driving restatements down, according to Carol Stacey, vice president at the SEC Institute and a former chief accountant at the SEC. The Commission has been trying to move financial reporting to a more principles-based approach for several years, but preparers and auditors have said that can’t be done when their judgments are second-guessed and overruled by the SEC. The agency may finally be responding to that criticism, she says.

“The staff is a little more willing to accept judgment on the part of registrants, where before they were challenging a lot of companies in the environment we were living in [in] 2002,” she says. “The majority [of the improvement] has to do with tighter, stricter controls, but in part it may be that the SEC is not challenging quite as much.”


Travis Harms, senior vice president at Mercer Capital, says restatements may also be declining because the kinds of transactions that subsequently lead to restatements have declined.

“When you look at things like mergers and acquisitions or the issuance of complex financial engineered securities, companies are generally doing less of that,” he says. “A restatement has to tie back to some economic event that happened. If there were fewer acquisitions, it would be natural that there would be fewer restatements from acquisitions.”

Where the Trouble Is

The causes behind restatements are also shifting, experts note. Problems with cash flow classifications, for example, have steadily risen as a cause for restatements, while revenue recognition problems have declined. Topping the list in 2008—even ahead of revenue recognition, which has been accounting’s primary headache for years—are problems with debt, payroll, cash flow, compensation, and mergers and acquisitions.


“Your guess is as good as mine,” says Bruce Pounder, president of accounting education firm Leveraged Logic. “Revenue recognition under Generally Accepted Accounting Principles is one of the most complicated areas. It may have just taken time for companies to get good enough at it so they don’t restate because of it as frequently.”


Below are excerpts from the Audit Analytics study of financial restatements from 2001 to 2008.

Calendar year 2008 has continued the decline in restatement disclosures noted in 2007.

In 2007, restatements declined by 31.4 percent (from 1800 to 1235). This decline continued in 2008, which experienced a total of 869 restatements filed by 778 unique companies. These figures represent a 31.4 percent drop in the amount of restatements (1235 down to 869) and a 30 percent drop in the number of unique filers (1111 down to 778). The downward trend appears to be attributable to the improved reliability of internal controls over financial reporting (ICFRs) implemented in response to the Sarbanes Oxley Act of 2002, but other

observers suspect that the drop in restatements, at least to some extent, is due to a more relaxed approach adopted by the SEC regarding materiality and the need to file restatements.

In addition to a drop in quantity, calendar year 2008 experienced an equivalence or drop in the severity of restatements as compared to prior years.

A. Negative Impact on Net Income

When looking at net income, both 2004 and

2005 experienced restatements that resulted

in very large negative adjustments. The

largest adjustment in 2006 was smaller, but

nevertheless substantial. In 2004, Federal

National Mortgage Assoc. (Fannie Mae)

restated its net income to reflect a negative

6.335 billion dollar impact while, in 2005,

American International Group Inc. (AIG)

disclosed a negative 5.193 billion dollar

impact. In 2006, Navistar International

Corporation disclosed a negative 2.377 billion

dollar impact. In contrast, the adjustments of

the last two years were much lower than the

past. General Electric’s negative adjustment

of 341 million dollars was the largest in 2007

and GLG Partner’s negative 605 million dollar

adjustment was the largest in 2008. Although

a little higher than the prior year, the dollar

value of 2008 ranks with 2007 as a very low

adjustment compared to the 5 years before 2007.

B. Negative Impact on Net Income

The continued drop in severity of restatements in 2008 is

best displayed by calculating, during each of the last four

calendar years, the impact an average restatement had on

the net income of companies traded on one of the three major

American stock exchanges (Amex, NASDAQ, and NYSE).

The typical restatement in 2005 and 2006 had a negative

adjustment of over 20 million dollars. This figure

dropped substantially in 2007, when the average restatement

had a negative impact of 7.4 million dollars. The figure

dropped again in 2008, with an average negative impact

of 6.1 million dollars. Therefore, not only did the number of

restatements fall in 2008, each of these fewer restatements

had a smaller negative effect than in the prior three years.

C. No Impact on Income Statements

When reviewing a restatement’s impact on income statement over the

last four years, from those companies trading on one of the three major

American stock exchanges (Amex, NASDAQ, and NYSE), the largest

percentage of restatements that had no impact on earnings occurred in

2008. Again, this measurement indicates that restatements are not as

severe in 2008 as compared to the prior three years. In 2008, a total of 99

out of 296 restatements had no impact on income statement (36. 45%) as

compared to 33.18% in 2007; 29.57% in 2006; and 24.88% in 2005.

D. Average Number of Days Restated

As shown in the graph on the right, the number of

days that were restated (the restatement period)

of the average restatement in a given year

peaked in 2005. In 2005,

the average restatement period was 747 days. In

2006, the time dropped to 718 days and dropped

again in 2007 to 646 days. This downward trend

was followed by a more substantial drop in 2008,

where the average restatement period was 479

days. Therefore, when compared to the prior

three calendar years, the average restatement in

2008 did not have to look back as far into the past

in order to correct previous financial statements …

The top eight issues in 2008 have been common causes for restatements over the last seven years except for the cash flow statements classification errors, an issue which has steadily increased in prevalence to be ranked third in 2008.

In 2008, the top eight accounting issues implicated in restatements were as follows:

debt, quasi-debt, warrants & equity security issues;

expense (payroll, SGA, other) recording issues;

cash flow statement;

deferred, stock-based and/or executive compensation


acquisitions, mergers, disposals, reorganization

accounting issues;

revenue recognition issues;

tax expense, benefit, deferral and other (FAS 109) issues;

liabilities, payables, reserves and accrual

estimate failures.


Audit Analytics (February 2009).

Stacey calls the shift dramatic, perhaps serving as a sign of the difficult economic times. “These are more of the issues you think would come up as a result of people manipulating numbers,” she says. With debt and equity issues, for example, “these are the types of securities companies are using to raise capital, and they’re more complex by nature. Security holders may be demanding more terms to get the protection they need.”

The rise in cash flow problems is also indicative of the current economic climate, Whalen says. “It could be due to the fact that people are shifting to more of a cash-flow look at things,” he says. “We might see that crop up even more often in the future.”

Another important undercurrent in restatements is how often companies are filing “stealth” restatements—that is, restatements filed without a prior Form 8-K disclosure that the original numbers are wrong and unreliable. The raw number of stealth restatements is down in 2008 from the peak year of 2006, but they still make up 51 percent of all restatements filed last year, Audit Analytics says.

Companies are allowed to skip the Form 8-K disclosure if the adjustment to financial statements is deemed immaterial. That leads Whalen to wonder if a larger percentage of restatements are immaterial corrections, or if companies are improperly portraying them as such. Audit Analytics is planning further research to see if it can answer that question, although it won’t be straightforward because there’s no clear-cut definition of materiality.

Pounder says the large number of stealth restatements could indicate that companies believe SEC enforcement in that area is light.

“Given SEC’s limited resources, enforcement for not having filed the 8-K timely is unlikely,” he says. “That doesn’t justify the practice, but I believe the incidence of stealth restatement has increased because companies feel that’s an area they can get away with.”


Stacey says the U.S. Government Accountability Office has advised the SEC to consider new rules to reduce the frequency of stealth restatements, and SEC staff signaled early in 2008 that it would consider the idea. “The staff should go forward and do this rule,” she says. “It would clarify things for companies and the market.”

The drop in restatements shouldn’t be taken as a sign to ease up on the financial reporting process, experts advise. Given the current economic climate, it could simply be a calm between storms.


“It wouldn’t be surprising as the focus moves toward cash preservation and fair valuation that reporting will become more difficult in some areas,” says Avi Alpert, senior director at the Controllers Leadership Roundtable. “As companies’ overall conditions deteriorate, we might see some new issues crop up.”

Pounder notes that the current economic stress is the right environment for fraud to proliferate. “We may be seeing a couple of years into the future the effects from that if those things do occur,” he says.