According to Audit Analytics®, Financial Restatements 2014 – A Fourteen Year Comparison, during the last five years, the quantity of restatements has leveled off and the severity has remained low, but a material restatement from accelerated filers has increased for the fourth straight year. So let’s review the three main questions and answers regarding restatements:
- Do restatements impact a company?
- If so, for how long?
- What can SEC companies do about it?
Does a Material Restatement Matter?
Absolutely. They impact the company both internally and externally. Internally, restatements generally prove to be challenging and to the accounting department that must continue performing their “day job” while juggling the responsibility of calculating, correcting and reporting the error. Additionally, restatements are often technically complex – so complex that management may not possess the expertise to tackle the project alone. Besides the internal opportunity or other costs, there may be additional costs with external advisors such as counsel and the auditors.
Externally, management must communicate with various stakeholders and regulators by design. For instance, the SEC has required filings and timelines specifically related to restatement financial statements. One of the most important external aspects of a restatement is the bearing on investor confidence. In the study, Is the Decline in the Information Content of Earnings Following Restatements Short-Lived?, jointly conducted by professors at Singapore Management University and Boston College, researchers measured the effect of a restatement due to declines in the information content of earnings. “Information content” describes the extent to which earnings announcements direct stock prices. The less confidence investors have in the accuracy of a company’s earnings, the less impact that information will have on their investment decisions.
How Long Does the Impact of a Material Restatement Last?
Conventional wisdom was based on a previous study that indicated that the negative impact on of a material restatement on stock price was short-lived; the stock price bounced back in approximately 9 months or three quarters. The new study, which is based on a more comprehensive and recent sample, indicates that a restatement’s impact on stock prices is longer-lived than previously thought. The new study concluded that the impact, caused by a loss of financial credibility, is felt for closer to 3 years (11 quarters).
What Can SEC Companies Do to Help Guard Against Material Restatements?
Companies can focus in two areas: prevention and mitigation. As with any “problem” prevention is preferred. Companies can prevent restatements by first understanding what causes the most restatements. There are various surveys, articles, etc. that describe the areas most prone to restatement, such as, but not limited to:
- revenue recognition,
- equity awards,
- financial instruments,
- income taxes,
- leases, and
- financial statement classification.
If your company engages in these topics, then ensure that you have the right staff, up-to-date training, appropriate specialists, and strong internal controls supporting these processes. If you don’t have the appropriate staff, then hire a CPA firm with expertise in these areas. Also, keep up with changes to your entity, its transactions, the accounting, or regulatory rules since changes can often lead to issues.
If your company does have to restate its financials, then get your team together, ensure you have all the data, confirm your team has all of the required skills, and hire specialists or otherwise augment your team as needed. Also, perform a root-cause analysis of the controls that more than likely broke down, and capture ideas for fortifying them. Communicate regularly and appropriately with regulators and stakeholders.
Beyond the normal internal change management necessary, the study found that firms could mitigate the impact of restatements by taking prompt remedial actions to regain investors’ trust. For instance, management could increase accounting conservatism, remove the CEO and CFO, and replace the external auditor or audit committee chair.
Do you have questions about material restatements and how to prevent this issue for your SEC company? Contact CRI’s SEC CPA team to see how CRI can help you avoid material restatements and manage your financial statements.