Putting Financial Revisions and Restatements in Perspective

Published on March 25, 2020

The state of the capital markets, and ultimately, corporate reporting, impacts every person in unique and significant ways — as consumers and investors. And no one cares more about the integrity and quality of corporate reporting more than the public company auditing profession, recognizing that financial revisions and restatements are indicators of audit quality. For nearly two decades, the story told by those indicators has been positive. Audit Analytics recently reported that "total restatements dropped for four consecutive years to an 18-year low." 

The issue of revisions and restatements, however, is not a simple one. In fact, it comes with considerable complexities and nuance, especially when drawing a link between revisions or restatements and audit quality. Amid these complexities, here are three important points to remember. 

1. Revisions and restatements themselves can be a sign that the system is working. 
Companies make revisions to — and even restate — their financial statements to correct mistakes before they become even larger market-level problems. This is a feature, not a bug, in our system of investor protection. Companies have incorporated a comprehensive approach to financial reporting, internal controls, and corporate governance, enabling them to more effectively hold themselves accountable to mistakes and be transparent in their reporting to investors, all under the watchful eyes of audit committees and independent auditors. And in some cases, it is the auditor that has detected the mistake, elevated it to the audit committee, and challenged the company to take necessary but sometimes difficult steps to correct and disclose the error. 

In short, the decision to revise financial statements — through either revisions or a restatement disclosed via Form 8-K — is determined by a number of parties, including the company’s audit committee, management and legal counsel. The auditor’s role is to understand all stakeholders’ views and independently evaluate the nature and extent of misstatements.

2. Financial revisions and restatements are indicators of audit quality, but they are far from the only ones. 
The encouraging trends in financial restatements have become a common point of reference in the discussion around audit quality. Yet we shouldn’t oversimplify. 

Firms achieve their audit quality objectives through a combination of many things. Many of these considerations are highlighted in the Center for Audit Quality’s framework for audit firms to use to disclose how they assess audit quality. These range from a firm’s leadership, culture and governance to its clients, engagements and monitoring. The willingness and courage of auditors to ask questions and challenge assumptions about financial reporting is what brings integrity and transparency to the capital markets for investors. In fact, as noted above, it may be the quality of the audit that detects the error that results in a restatement or revision.

Each financial restatement or revision has a different set of facts around it: who detected it, when it was detected, how big it is, whether there was fraud or just plain error, and more. It is incorrect to draw blanket conclusions about audit quality based solely on this one metric, especially when the number of restatements in any given year represents a tiny proportion of the total number of audit opinions issued.

3. While revisions and restatements are declining, they are likely to always be with us. 
Why? While advanced technologies like artificial intelligence continue to accelerate opportunities to improve audit quality, our financial reporting system is largely a human system — and these humans make mistakes. No system of internal controls can eliminate all errors or stop every fraud. So, while the U.S. financial reporting system is one of the most effective and robust in the world, it is not perfect, nor can it ever be.

Recognizing our imperfections is why continuous improvement in audit quality will always be a top priority for the audit profession. Continuous improvement also is the reason why companies continue to embrace transparency and integrity in their disclosures. With these trends in place, while financial revisions and restatements may always be part of the financial reporting landscape, so too, happily, will be a robust culture of accountability and transparency.

(Source:  AccountingToday – Daily Briefing – Voices – February 12, 2020)