Audit Analytics (AA) has released its annual report on public company restatements, 2020 Financial Restatements: A Twenty-Year Review. AA found that the number of restatements in 2020 fell to 364 – the fewest since AA began tracking restatements in 2001 and 26 percent fewer than in 2019. See How Low Can They Go? Restatements Hit Another New Low in 2019, September 2020 Update. After holding relatively constant from 2009 to 2014, the number of restatement disclosures has now declined for six years. The 364 restatements in 2020 were filed by 336 companies and, overall, 4.93 percent of the SEC public company filer population (excluding funds and trusts) restated their financial statements in 2020. This reflects a drop from 6.8 percent in 2019 and 17 percent at the peak in 2006.
Big and Little R
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 due to a material error, 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 immaterial errors, and 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 may simply be included in a subsequent periodic SEC filing with the restatement disclosed in the footnotes to the current financial statements. These less significant restatements are called “revision” or “Little R” restatements. Revision restatements typically attract less public attention and market reaction than reissuance restatements.
Out-of-period adjustments (OPAs) are a third method of correcting immaterial errors in prior financial statements. OPAs are corrections of prior period errors in the current period. OPAs are not restatements because previous financial statements are not affected.
2020 Report Highlights
In addition to the record low restatement numbers noted above, highlights of the 2020 AA report include:
The great majority of restatements were deemed to be immaterial. Revision restatements (75.7 percent of all restatements) exceeded reissuance restatements (24.3 percent of the total) by slightly more than a 3:1 ratio.
The average net income impact of restatements rose sharply in 2020. The 2020 average restatement net income impact was negative $17.6 million -- the fourth highest in the past 18 years. In contrast, the 2019 average impact of negative $1.7 was the lowest since AA has tracked this metric. AA attributes the surge in average net income impact to three factors. “First, there were several restatements in 2020 that had large negative impacts on net income. Second, the average adjustment for restatements that had a positive impact on net income was historically low. And third, 2020 saw the greatest proportion of restatements [37.2 percent] that had a negative impact on net income since 2011.”
Reissuance or Big R restatements were filed more quickly. AA tracked the period of time that elapsed between disclosure of the fact of the misstatement and the filing of the restatement. The average number of days to file a restatement in 2020 declined to 39.9 from 65.2 in 2019.
The average number of days restated dropped for the fourth consecutive year. Days restated is a measure of restatement severity. In 2020, it averaged 447 days, compared to 451 days in 2019.
The average number of accounting issues per restatement rose slightly. In 2020, the average number of issues disclosed per restatement was 1.57, slightly higher than the 1.51 issues per restatement in 2019. This metric peaked at 2.48 issues per restatement in 2005.
Accelerated filers and foreign issuers were less likely to restate. Restatements by non-accelerated U.S. filers increased from 36 percent in 2019 to 53.3 percent of total restatements in 2020. Restatements by accelerated U.S. filers decreased from 46.0 percent to 31.3 percent. Restatements by foreign issuers decreased from 18.0 percent to 15.4 percent.
Revenue recognition was the accounting issue most frequently involved in restatements. Revenue recognition was cited in 17.3 percent of restatements. The next four most common restatement accounting issues were: Debt and equity securities (14.3 percent); Liabilities and accruals (12.6 percent); Tax matters (12.1 percent); and General expenses (11.0 percent).
Comment: 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. 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 and continue to decline.
The culture around restatements may also have changed. Whether to correct a prior error by a reissuance restatement or a revision restatement (which attracts less public attention) is to some degree a matter of judgment. The share of restatements that are Little R rather than Big R has increased over the years and, as noted above, in 2020 over 75 percent of all restatements were by revision, not reissuance. AA notes that claw back policies can influence a company's desire to classify a restatement as a revision. Under a claw back policy, executive compensation based on reported financial results must be repaid to the company if the underlying financial statements are restated. Many companies have adopted such policies, and the SEC has proposed to require claw backs. See SEC Revives a Proposal to Require Compensation Claw Backs After Restatements, September-October 2020 Update. Under the SEC’s proposal, repayment of executive compensation would be mandatory when a reissuance restatement is disclosed but would not apply to revision restatements.
Audit committees confronted with the need to restate should make sure they fully understand the reasons for the restatement method – reissuance or revision – chosen by management. This may become an area of greater SEC scrutiny in the future.