A financial statement restatement is the result of a change in accounting principles or an error. A restatement often involves a completely new audit and could affect future financial statements in the coming year.
The purpose of a financial statement restatement is to revise an earlier issued set of financial statements. The reasons for revisions were recently studied by the General Accounting Office at the request of Congress. The primary reasons were found to be…”to adjust revenue, costs or expenses, or to address security-related issues”. The study also found that the restatements could be prompted by the restating company itself, the Securities and Exchange Commission or by the auditing firm of the company.
The size of financial statement restatements is usually very large. One reason for this similarity is that if the error or misstatement was not “material” or significant for the company, there would be no reason to make a change. When the error or misstatement is material enough to warrant a restatement, investors and employees usually react negatively; rarely do companies restate for good changes.
The effects can be enormous and spread throughout our markets very quickly. When Adelphia reported 2001 financial statements that included previously omitted off balance sheet items, the stock price hit the fell. Adelphia and about 200 hundred of its subsidiaries filed for bankruptcy within six months. When financial statement restatements are issued to uncover hidden debts or expenses that damage the company’s performance ratios, the effects are far reaching.
There are many theories and speculations whenever a financial statement restatement is issued. The first is normally fraud; market watchers automatically start selling the stock to avoid losing their investment. Most of the time, as mentioned earlier, these restatements are not good news. However, the reason for the financial statement restatement is normally announced at the time the restatement is made. Therefore, there is very little time to speculate and react to the news before the stock price is affected.
Many investors, employees and government officials begin to look to the auditors to find reasons for these misstatements. Often times, it is the auditor who discovered the error or omission for management. However, a common misconception regarding the audit of financial statements is that the purpose of the audit is to detect fraud. The purpose of an audit is to determine, to the best of the auditors’ ability, with the information available to them, whether the information is presented in accordance with Generally Accepted Accounting Principles. Many times, insiders can disguise information or keep amounts below the materiality level of auditors.