How Low Can They Go? Restatements Hit Another New Low in 2019
Audit Analytics (AA) has released its annual report on public company restatements, 2019 Financial Restatements: An Nineteen Year Comparison (available here for download). AA found that the number of restatements in 2019 fell to 484 – the fewest since AA began tracking restatements in 2001 and 32 fewer than in 2018. See Restatements Continue to Decline, Despite an Uptick in Changes Driven by Revenue Recognition, August 2019 Update. After relatively constant restatement totals from 2009 to 2014, the number of restatement disclosures has now declined for five consecutive years. The 484 restatements in 2019 were filed by 444 companies. Overall, 6.34 percent of the SEC public company filer population (excluding funds and trusts) restated their financial statements in 2019 – the lowest percentage since AA began tracking this parameter in 2006.
As explained in Restatements Hit Another New Low, and SOX Could Be the Reason, July 2017 Update, restatements fall into two categories. When a company determines that users can no longer rely on previously issued financial statements, it is required to disclose that determination by filing SEC Form 8-K within four business days. Restated financial statements would normally be filed sometime later, after the company has had the opportunity to analyze and correct the errors. This type of restatement is referred to as a “reissuance” or “Big R” restatement. In contrast, if a company determines that previously issued financial statements contain errors, but that, despite the errors, users can continue to rely on the financial statements, it is not required to file Form 8-K. Corrected financial statements would simply be included in a subsequent periodic SEC filing. These less significant restatements are called “revision” or “Little R” restatements. Revision restatements typically attract less public attention and market reaction than reissuance restatements.
In addition to the record low restatement numbers noted above, highlights of the 2019 AA report include:
The severity of restatements continued to decline. For example—
Revision, or Little R, restatements were 79.7 percent of all restatements in 2019. In 2018, Little R restatements were 74.3 percent of the total.
In 2019, 56.8 percent of restatements had no impact on the income statement. In 2018, 53.6 percent did not affect earnings. AA observes that the 2019 percentage “to some degree, is due to cash flow statement errors, which have no impact on the income statements.”
The average number of days restated dropped for the third consecutive year, averaging 451 days in 2019.
The average number of accounting issues per restatement dropped for the second year in a row, averaging 1.51 issues per restatement in 2019.
Restatements are being filed more quickly after disclosure of the misstatement. AA reviewed the average number of days between initial disclosure of the need to restate and the filing of the restatement. For companies traded on the three major stock exchanges, the average period between disclosure and restatement in 2019 was 6.5 days. By comparison, in 2007 this period was about 30 days. AA’s explanation of this acceleration is two-fold. First, since the time needed to restate is less for less complicated errors, a “high percentage of revision restatements would cause a decrease in the average time period needed to restate.” In addition, “improved internal control over financial reporting (ICFR) would allow a company to recalculate and restate financials more quickly after an error is discovered. Improved ICFR could cut response time, notwithstanding the complexity of the restatement at hand.”
Revenue recognition was the accounting issue most frequently involved in 2019 restatements. After revenue recognition, the most common restatement accounting issues were:
Cash flow statement.
Debt, quasi-debt, warrants and equity security issues.
Tax expense, tax benefit and tax deferral, and other tax accounting issues.
Liabilities, payables, reserves, and accrual estimates.
Accounts/loans receivable, investments, and cash issues.
Expense (payroll, SGA, other) issues.
Comment: The decline in the number and severity of restatements during the past 19 years seems to confirm that the Sarbanes-Oxley Act has strengthened the quality and reliability of public company financial reporting. Restatements peaked in 2006 at 1,842. The 2006 peak occurred during the period when public companies and their auditors were devoting a new level of scrutiny to internal control over financial reporting in the wake of the implementation of the Sarbanes-Oxley Act requirement to assess and report on ICFR effectiveness. Since 2006, restatements have declined substantially. At least as measured by restatement frequency and severity, the substantial investment companies have made in strengthening and monitoring the effectiveness of their controls seems to have paid off.