Financial restatements- Understanding the significance

Financial restatements- Understanding the significance

Within the last few years, the corporate reporting environment has been reshaped by revised corporate reporting standards. Corporate officers, auditors and audit committees are involved in the efforts of publicly traded companies to provide accurate corporate financial reports to their investors. But often, mistakes make their way into financial statements of public companies, and when they do, what happens next can vary depending on the timing and severity.  Every corporate office is required to certify that quarterly and annual financial statements are fair in all material respects, financial condition and operational results .It is mandatory to correct a financial statement error which is done from restatement.

The Financial Accounting Standard Boards (FASB) defines a restatement as a revised form of previous financial statements issued in order to correct an error. Management is responsible to identify the errors but it is also identified by some regulatory such as U.S Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB). Generally, independent auditors discover misstatements in financial statements during audit and inform managers and audit committees of such findings. Auditors, managers, and the audit committees then evaluate the nature and materiality of misstatements and make decisions prior to issuing the financial statements. Managers may waive correcting misstatements that are deemed to be immaterial.

SEC’s rule for restatements
Additional Form 8-K Disclosure Requirements and acceleration of filling date, requires to be filed by a reporting company to announce restatements if the company concludes an announcement stating previous issued financial statements should no longer be relied upon because of an error detection in such financial statements. This statement should be made within 4 days after the company made such an announcement. If the same information is to be disclosed in scheduled quarterly or annual reports issued before the end of the four-day window, however, the reporting company need not announce the restatements. In practice, there is an increasing trend of filing restatements without first announcing them because the determination of the day previously issued financial statements should no longer be relied upon is subject to the discretion of the companies and their auditors.

Big R statements & Little R statements
If an error is material prior period of financial statements, a company is required to restate previously issued financial statements and correct the error (e.g., in a Form 10-K/A filing or, in some cases, the next Form 10-K filing). In this case, audit opinion is also revised to disclose the restatement referring financial statement footnote that describes the error and related correction. This type of restatement is commonly known as a Big R restatement.

Little R statements are the instances when an error is discovered which is not material to prior period financial statements. The company would still need to disclose the correction in the footnotes of the current period financial statements. However, they do not require the independent auditor to modify its opinion because the prior period financial statements were not materially misstated.

SEC’s role in assessment of restatements and company responses
SEC reviews public companies for violating security laws and compliances with financial reporting standards are required. Also, it initiates informal comment letters requesting clarifications after reviewing disclosures and transactions already reported in firms periodic reports, and may subsequently issue a formal comment letter if a public company’s response to an informal comment letter is deemed insufficient. Recent developments suggest a trend towards prosecuting executives responsible for wrongdoing beyond reaching settlements with their companies. Since the causes of restatements vary, there is a variety of factors for investors to consider when assessing a restatement including cause and significance of the error, likelihood of its reoccurrence, preventive measures, including consideration of internal controls; the company is employing to prevent such an error from happening again.

In conclusion, a clear communication with the investors regarding a restatement should be initiated. Companies should convey correct news surrounding a restatement by explaining pros and cons, how the company is responding including any corrective measures need to be followed. Ambiguity in response to financial reporting errors can lead to a misrepresentation of facts and fraudulent activities.

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