More big, public companies are asking the Securities and Exchange Commission for a do-over.
Despite the improving economy, the largest public companies filed an increased number of financial restatements for the second straight year in 2012, although the significance of restatements overall continued to decline.
According to the latest data from research firm Audit Analytics, U.S. publicly held companies issued 768 restatements in 2012, down 6.3 percent from 2011 and 57 percent from the spike that occurred in 2006. Companies corrected an average of 1.38 accounting errors per restatement, also steadily declining from a 2005 spike of 2.44 issues per restatement. And the period of time covered by a restatement averaged 534 days, a slight increase from 2011 but still holding in the low 500s where it has hovered for the past five years after a high of 749 days in 2007.
Amid all of those numbers that indicate improvements in financial reporting, however, the raw number of restatements issued by accelerated filers (representing those with a market capitalization of more than $75 million) increased by 21 percent, from 202 in 2011 to 249, in 2012. And that followed a similar increase from 2010 to 2011, according to the research data.
Chris Wright, managing director at consulting firm Protiviti, believes there's a logical link. Larger companies are naturally more complex and more prone to have problems with complex areas of accounting that are under tight scrutiny these days, but they are finding problems that are less material, less severe, and easier to fix, he says. “You can see how those factors would play together,” he says.
Don Whalen, research director for Audit Analytics, says he can find no explanation in the data for why the largest public companies are filing an increasing number of restatements when non-accelerated filers are filing fewer. “Usually a reason for an increase can be identified, but a review of the restatements does not reveal any trends,” he says. “This makes me suspect that it could be caused by the regulators—the SEC and the Public Company Accounting Oversight Board—via inspections and comment letters.”
Bent on emphasizing audit quality, the PCAOB has flagged an increased number of audits in the last two years as deficient in its inspection findings across all the major audit firms, which audit the vast majority of accelerated filers. It mentions very few cases in its inspection reports where a PCAOB inquiry into a deficient audit eventually led to a restatement.
“I don't know that you have all the evidence you need to connect the dots, but there is the potential some of what we are seeing here is connected to inspection reports,” says Wright. He calls it the “ripple effect.” As the PCAOB focuses on specific, high-risk issues in its inspections, firms may take note and begin paying closer attention to those issues throughout their audit work, perhaps kicking up issues to resolve in other companies' financial statements, he says.
Carol Stacey, vice president at training firm SEC Institute and a former chief accountant for the SEC, says PCAOB inspections are unlikely to directly drive a heavy number of restatements because they don't look at all audit work. The PCAOB's 2011 annual report notes the board looked at portions of 845 audits that year, and only 340 of those were performed by the largest audit firms. That's a fraction of the thousands of public company financial statements that are filed each year, she notes.
“Usually a reason for an increase can be identified, but a review of the restatements does not reveal any trends. This makes me suspect that it could be caused by the regulators.”
—Don Whalen,
Research Director,
Audit Analytics
“The PCAOB hits a very small part of the issuer population because its focus isn't on issuers,” she says. “That's the SEC's job.” The SEC send more than 10,000 comment letters to companies taking issue with accounting applications, although it doesn't track how many of its comments on public company filings lead to restatements.
Revision Restatements
Bert Fox, a partner in the professional standards group at Grant Thornton, says he would not be surprised if further research into the cause for accelerated filer restatements revealed that PCAOB inspections drive an increased number of “revisions restatements,” as Audit Analytics defines them. If companies find serious problems that they need to correct and warn investors about immediately, they are required to file a Form 8-K. However, if they need to correct immaterial errors that do not affect investors' reliance on financial statements, they are permitted to do so through the next periodic filings.
Audit Analytics' research shows revision restatements represent a steadily increasing share of total restatements—65 percent in 2012, up from 57 percent in 2011 and 54 percent in 2010. “The work we are doing to satisfy the PCAOB is not really resulting in us finding material errors,” Fox says. “In fact, it's very rare you'd have a PCAOB inspection identify a material error to financial statements.”
The issues most commonly leading to restatements, according to the study, are the same issues often cited as the most complex areas of accounting, and therefore are scrutinized heavily by regulators. Those include issues related to debt, quasi-debt, warrants and equity, and taxes.
12 YEARS OF RESTATEMENTS
Below is a chart from Audit Analytics showing total restatements by year from 2001 to 2012.
Source: Audit Analytics.
Sophisticated deal making produces transactions that contain a mix of debt and equity elements, making it tricky to sort out the accounting. Stacey says she finds it frustrating to see the same issues cropping up year after year, especially the accounting for debt and quasi-debt instruments. “The accounting in some areas is always trying to keep up with the deals that were going on,” she says. “People don't realize that in these agreements are things embedded that can cause problems later.”
The Financial Accounting Standards Board had planned to take a fresh look at the accounting rules for debt and equity, but shelved the project in late 2010 to focus more on its major convergence projects with the International Accounting Standards Board. “This is an area where the rules could use some improvement,” says Fox.
Another common problem area that causes restatements is accounting for taxes, where tax law at multiple levels and in multiple jurisdictions adds an extra element of complexity. Mark Plichta, a partner with law firm Foley & Lardner, says many companies in recent years have encountered problems with valuation of deferred tax assets. “The reserve number for tax assets can be highly subjective,” he says. If companies take overly aggressive or overly conservative positions, they will have to be adjusted in future reporting periods, he says.
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