Ideagen Audit Analytics (AA) has released its annual report on public company restatements, Financial Restatements: A 20-Year Review 2003-2022. AA found that SEC filers disclosed 454 restatements in 2022, down 69 percent from 1,467 restatements in 2021. The 2022 restatements were filed by 421 companies (5.1 percent of SEC registrants), compared to 1,040 companies (12.8 percent of registrants) that restated in 2021. Restatement frequency in 2022 was roughly similar to 2020 and 2019. In 2020, 4.9 percent of companies restated (374 total restatements), and, in 2019, 5.7 percent of companies restated (460 total restatements). 2021 was an outlier because of the large number of restatements filed that year by special purpose acquisition companies (SPACs). In 2021, there were 754 SPAC restatements; SPAC restatements fell 91 percent (to 71) in 2022. (For an analysis of AA’s prior restatement report, see Fueled by SPACs, Restatements Surge, June-July 2022 Update. Note that some figures previously reported for 2021 and prior years appear to have been revised in AA’s current report.)
Big R and Little R Restatements
As explained in the introduction to AA’s report (and in Restatements Hit Another New Low, and SOX Could Be the Reason, July 2017 Update), companies have three methods for correcting errors and misstatements in previously-issued financial statements – a reissuance restatement, a revision restatement, or an out-of-period adjustment.
When a company determines that financial statement users can no longer rely on previously issued financial statements due to a material error, it must disclose that determination by filing SEC Form 8-K within four business days. The company then files restated financial statements after it has had the opportunity to analyze and correct the error. This type of restatement is a “reissuance” or “Big R” restatement.
When a company determines that previously issued financial statements contain immaterial errors, and that, despite the errors, users can continue to rely on the prior financial statements, the company may simply include corrected financial statements in a subsequent SEC periodic filing. In that filing, the restatement must be disclosed in the footnotes to the current financial statements. These less significant restatements are “revision” or “little r” restatements. Revision restatements do not require a Form 8-K filing and typically attract less public attention and market reaction than reissuance restatements.
Out-of-period adjustments (OPAs) are also a method of correcting immaterial errors in prior financial statements. OPAs correct the prior period error by making an adjustment in the current period financial statements. OPAs are not restatements because they do not affect previous financial statements. An OPA is only appropriate when the correcting adjustment does not have a material effect on the current period financial statements. (Since they are not restatements, AA’s annual reports do not include OPAs.)
SPAC Restatements
The 2021 SPAC restatement surge was primarily in response to an SEC staff statement issued in April 2021. See Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”). This statement urged SPACs to reconsider the accounting treatment of redeemable shares and warrants. Most SPACs recorded shares that included a redeemable feature as permanent equity. The SEC objected and requested the shares be recorded as temporary equity. In addition, the SEC staff asked SPACs and companies that had gone public via a SPAC merger to consider whether warrants recorded as equity should instead be treated as liabilities, subject to fair market value adjustments. As a result, 452 SPACs filed 754 restatements in 2021. While SPAC restatements were down sharply in 2022, SPACs continued to restate at a higher rate than the general SEC filer population.
2022 Restatement Report Highlights
Highlights of AA’s current restatement report include:
Little r restatements continue to predominate, although the long-term trend may be changing. There were 190 domestic filer reissuance (or Big R) restatements (44 percent of the total) in 2022. This represents a decline from 63 percent in 2021; SPAC reissuance restatements inflated the 2021 figure. Until 2021, domestic filer reissuance restatements had declined as a percentage of the total every year AA measured. However, ignoring 2021, the 44 percent reissuance restatement percentage in 2022 is higher than in any year since 2011.
Debt/equity accounting is still the issue most frequently involved in restatements. Debt/equity accounting – typically the issue involved in SPAC restatements -- was the most-frequently cited restatement issue in both 2021 and 2022; in 2022, the percentage of total restatements disclosing debt/equity errors was 22 percent. The other top five issues in 2022 were revenue recognition (12 percent), liabilities (11 percent), expenses (9 percent), and deferred, stock, executive compensation (9 percent).
The smallest companies file the most restatements. As has been the case in every year AA has studied, most restatements come from smaller public companies. In 2022, 245 restatements (54 percent of total restatements) were filed by nonaccelerated filers. (Since SPACs are typically nonaccelerated filers, these figures include SPAC restatements.) At the other end of the size spectrum, large accelerated filers accounted for 95 restatements (21 percent of the total). Accelerated filers (the size tier between non-accelerated filers and large accelerated filers) submitted 51 restatements (11 percent of the total). AA does not explain the source of the remaining 14 percent of restatements, although these were presumably from foreign companies.
The average number of days restated rose over 2021 but fell compared to 2020. The restatement period (the number of days encompassed by the restatement) is a measure of restatement severity. In 2022, the average restatement period was 391 days. This compares to 447 days in 2020, prior to the SPAC surge. In 2021, the average restatement period was 287 days, although this (relatively) shorter period reflects the fact that, on average, SPACs had less than a year (201 days) of financials to restate.
Restatements that impact income tend to correct errors that erroneously increased net income. Overall, 30 percent of total restatements had an impact on the company’s net income. Of these, 32 percent had a positive impact, while 68 percent reduced net income. (Stated differently, 68 percent of the income-affecting errors that were corrected by restatement had improperly increased net income.) By comparison, in 2021 32 percent of restatements had an income effect; 20 percent of those restatements had a positive net income impact, while 80 percent were negative. In 2022, the average negative restatement impact on net income was minus $11.6 million, the smallest average negative impact on net income since 2009. The average positive net income effect in 2022 was $10.5 million.
Comment: As the Update has previously observed, the overall trend in restatements is down. Since 2006, restatements (ex-SPACs) have declined substantially. The investments that companies have made in strengthening their internal control over financial reporting in the wake of the implementation of the Sarbanes-Oxley Act seems to have paid off in less frequent material financial statement errors.
Audit committees should however also bear in mind that some of the decline in restatements may be the result of a change in restatement “culture” – and that the culture may be resetting. SEC Chief Accountant Paul Munter has signaled that the SEC staff believes companies and their advisors have been taking an unduly narrow view of materiality and that many errors treated as immaterial should have triggered a reissuance restatement. See SEC Acting Chief Accountant Warns Against Bias in Restatement Materiality Decisions, March 2022 Update. Audit committees confronted with errors in prior financial reporting and questions concerning whether and how to restate should make sure they fully understand the reasons for management’s proposed choice between a reissuance or revision restatement. The SEC may inquire into the audit committee’s role in cases where it disagrees with a company’s determination regarding the handling of a financial statement error, and committees should be prepared to show that they provided active oversight.