Restatements in Accounting

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Corporate restatements are defined by Audit Analytics as ‘errors due to unintentional misapplication of U.S. GAAP.’. In contrast, corporate financial frauds are defined as ‘intentional manipulation of financial data or misappropriation of assets.’ (Mintz, 345). Material or immaterial misstatements may require a reissuance or revision of the prior years’ financial statements. Typically, material misstatements indicates some sort of accounting failure at the entity which requires a reissuance of the financial statements. In contrast, immaterial misstatements, typically due to accounting errors, may only require a revision of the previous financial statement(s); revision restatements accounted for approximately 80% of the SEC 8-K restatements in 2019.
Restatements may signify a weakness in the internal controls’ framework over financial reporting, lack of corporate governance framework, and/or issues with the ethical leadership tone at the top, which is typically the case with fraudulent financial reporting and earnings management cases. Companies today are not filing their restatements in the 8-K, rather in the 10-K/A or 10-Q/A, which does not require the company to disclose the restatement for the period it affected, rather it is amended in the subsequent periodic report(s) and is defined by the SEC as a stealth restatement. Common issues cited in restatements include taxes, revenue recognition, expense recording, inventory, and value diminution of PPE intangibles or fixed assets. Operational issues are often determined to be some fashion of earnings management.
Restatements due to operational issues can trigger restatements due to the timing or classification of a particular accounting treatment. Improper entries around the timing of expense or revenue recognition, or the improper classification of assets or revenue can misrepresent the entity’s financials, and whether material/immaterial, can cause the financial statements to require a restatement of some sort.
‘Managers act as the agents of the shareholders who expect management to act in the shareholders’ best interests. For many shareholders, this means to maximize profit, increase the value of the stock, and facilitate stock options.’ (Mintz, 256). These are the types of pressures that may influence management to manage the earnings. In contrast, investors and creditors require accurate financial information to assess future earnings. By having a strong corporate governance culture and ethical tone at the top, financial statement users can be assured that sound ethical practices and reasoning exist to inform the objectivity expected in accounting and issuance of financial statements. By segregating key responsibilities and creating an environment which promotes independence, companies can deter management from overriding internal controls and creating a pressure-laden culture lacking ethical leadership ultimately diminishing the tone at the top.