When a company reissues or revises its financial statements, some people automatically assume that management is cooking the books. But there can be legitimate reasons for restatements, beyond management incompetence and fraud. So, before leaping to conclusions, it’s important to understand what went wrong — and find ways to prevent future restatements.
Often, owners and managers are more focused on running the business than staying on top of today’s increasingly complex accounting rules. Inadvertent mistakes and misinterpretations may cause an occasional restatement.
Restatements typically occur when the company’s financial statements are subjected to a higher level of scrutiny. For example, restatements may occur when a company:
- Converts from compiled or reviewed financial statements to audited financial statements,
- Decides to file for an initial public offering, or
- Brings in additional internal (or external) accounting expertise, such as a new controller or audit firm.
The restatement process can be time consuming and costly. Regular communication with lenders and shareholders can help overcome the negative stigma associated with restatements. Management also needs to reassure employees, customers and suppliers that the company is in sound financial shape to ensure their continued support.
Common sources of financial restatements include recognition errors and misclassifications on the financial statements. For example, management might make recognition errors when implementing the new standards on accounting for leases or contract revenues in the near future. Or, you may need to shift cash flows between investing, financing and operating on the statement of cash flows, in accordance with recent guidance issued on reporting cash flow.
Equity transaction errors, such as improper accounting for business combinations and convertible securities, can also be problematic. Other leading causes of restatements are valuation errors related to common stock issuances and preferred stock errors and the complex rules related to acquisitions, investments and tax accounting.
The probability of error increases as the complexity of your transactions increases. Examples of hard-to-report activities include hedging, issuing stock options, using special purpose or variable interest entities, and consolidating financial statements with related parties.
Financial reporting can be challenging in today’s complex business environment. The best way to avoid restatements is to get it right the first time around. We can help you implement internal controls to test for errors and omissions, educate in-house accountants on changes to GAAP, audit your financial results and investigate the causes of any anomalies.