When it comes to making informed organizational decisions, accurate financial statements are essential. So, managers and other stakeholders may express concern when an organization issues financial restatements. However, before jumping to untimely conclusions, it’s important to dig deeper to evaluate what happened.

Uptick In Restatements 

In June 2024, the Center for Audit Quality (CAQ) reported a recent uptick in financial restatements by public organizations. The report, Financial Restatement Trends in the United States: 2013–2022, delves into a 10-year study by research firm Audit Analytics. It found that the number of restatements in 2022 had increased by 11% from the previous year.

More alarming is a trend toward more “Big R” restatements. Big Rs indicate that the organization’s previously filed financial reports were deemed unreliable by the organization or its auditors. Although most restatements are due to minor technical issues, the proportion of total restatements that were Big Rs rose to 38% in 2022, up from 25% in 2021. The 2022 figure is also up from 28% in 2013 (the peak year for restatements in the study) — and it’s the third consecutive year that the proportion of Big Rs has increased.

However, the CAQ report states, “It is too early to tell if the increase in restatements toward the end of the sample period is a true inflection point or simply a brief disruption of the previous downward trend.” Overall, financial restatements have decreased from 858 in 2013 to 402 in 2022.

Reasons For Restatements

The Financial Accounting Standards Board defines a restatement as a revision of a previously issued financial statement to correct an error. Whether they’re publicly traded or privately held, organizations may reissue their financial statements for several “mundane” reasons. For instance, management might have misinterpreted the accounting standards, requiring the organization’s external accountant to adjust the numbers. Or they simply may have made minor mistakes and need to correct them.

Common reasons for restatements include:

• Recognition errors (for example, when accounting for leases or reporting compensation expense from backdated stock options)
• Income statement and balance sheet misclassifications (for instance, an organization may need to shift cash flows between investing, financing, and operating on the statement of cash flows)
• Mistakes reporting equity transactions (such as improper accounting for organizational combinations and convertible securities)
• Valuation errors related to common stock issuances
• Preferred stock errors
• The complex rules related to acquisitions, investments, revenue recognition, and tax accounting

 
Often, restatements happen when the organization’s financial statements are subjected to a higher level of scrutiny. For example, restatements may occur when a private organization converts from compiled financial statements to audited financial statements or decides to file for an initial public offering. They also may be needed when the owner brings in additional internal (or external) accounting expertise, such as a new controller or audit firm.

Material restatements often go hand-in-hand with material weakness in internal controls over financial reporting. In rare cases, a financial restatement also can be a sign of incompetence or even fraud. Such restatements may signal problems that require corrective actions. However, the CAQ report found that only 3% of all restatements and 7% of Big Rs involved fraud over the 10-year period.

We Can Help

The restatement process can be time consuming and costly. Regular communication with interested parties, including lenders and shareholders, can help organizations overcome the negative stigma associated with restatements. Management also needs to reassure employees, customers, and suppliers that the organization is in sound financial shape to help ensure their continued support.

Accounting and tax rules are continuously updated and revised. So, your in-house accounting team may need help understanding the evolving accounting and tax rules to decrease the risk of restatements, as well as help them effectively manage the restatement process. Contact us for help addressing the latest rules, reinforcing your internal controls, and issuing reports that conform to current Generally Accepted Accounting Principles.