What Is a Restatement?
A restatement is an act of revising one or more of a company’s previous financial statements to correct an error. Restatements are necessary when it is determined that a previous statement contained a "material" inaccuracy. This can result from accounting mistakes, noncompliance with generally accepted accounting principles (GAAP), fraud, misrepresentation, or a simple clerical error.
- A restatement is a revision of one or more of a company’s previous financial statements to correct an error.
- Accountants are responsible for deciding whether a past error is “material” enough to warrant a restatement.
- An error can be considered material if the incorrect information would lead those receiving the statements to come to inaccurate conclusions.
- The FASB requires companies to issue a restatement to correct previously recorded errors.
- A reclassification involves correcting the classification of an entry.
Company management and independent auditors are responsible for ensuring that quarterly and annual financial statements accurately reflect the financial condition of a firm. Sometimes, previous statements need to be amended. At times, these mistakes will be spotted by internal auditors. On other occasions, it might be a third party, such as the Securities and Exchange Commission (SEC), that spots them.
The Financial Accounting Standards Board (FASB) requires companies to issue a restatement to correct previous errors. Accountants are responsible for deciding whether a past error is “material” enough to warrant a restatement.
Material is a loose term that is not accompanied by specific percentage guidelines and so forth. As a general rule of thumb, an error can be considered material if the incorrect information would lead those receiving the statements to come to inaccurate conclusions as part of a standard analysis.
If an issue or error is found that affects part of a financial document or the document as a whole, a restatement will likely be required. Additionally, if certain key information about the original statement is received after the first statement was released, a restatement may be issued to adjust the financials based on the discoveries.
The Dangers of Restatements
Many restatements are the result of innocent mistakes and basic misinterpretation. However, some can raise red flags, highlighting potential fraud or incompetence. Over-reporting a company’s gains can be very misleading. It can lead investors to believe the company is in a stronger financial position than is actually the case. Based on the inaccurate information, investors may perform actions, in regards to the previously made investments, that otherwise would not have been made.
Public companies must file SEC Form 8-K to alert the investment community of material changes, as well as reissue corrected financial statements.
Negative restatements are regularly frowned on, shaking investor confidence and causing share prices to decline. They can also lead to fines: Hertz Global Holdings Inc. (HTZ) was ordered to pay a $16 million civil penalty after internal auditors discovered errors in several of its previous financial statements. In 2015, the car rental company disclosed that restatements would weigh on profits for 2011, 2012, and 2013.
Real-Life Example of a Restatement
In February 2019, Molson Coors Brewing Co. (TAP) revealed it would restate its financial statements for fiscal years (FY) 2016 and 2017 after auditors discovered accounting blunders for income taxes related to deferred tax liabilities (DTL).
In a filing with regulators, the beer maker blamed the errors on its acquisition of a remaining 58 percent stake in MillerCoors in 2016. Understating deferred tax liability (DTL) and income tax expense boosted net profits by nearly $400 million in 2016. Overall, the company said it understated the value of the taxes owed but not yet paid on its balance sheet by $248m, and overstated its total equity by the same amount.
The finding did not inspire much confidence in Molson Coors Brewing’s accounting practices, as reflected by the sharp subsequent markdown in the company’s share price.
When a publicly traded company determines it needs to amend its financial statements, it must file SEC Form 8-K within four days to notify investors of non-reliance on previously issued financial statements. It also needs to file amended 10-Q forms for the affected quarters and possibly amended 10-Ks, depending on how many accounting periods are affected by the erroneous data.
Companies should also provide a breakdown of how past errors occurred, how they were corrected, and whether there will likely be any future ramifications in their latest financial statements. These comments usually appear in the footnotes.
When companies issue restatements, investors are advised to ascertain to the best of their abilities the seriousness of the error reported. How much of an impact is it likely to have and, more importantly, was it an innocent mistake, or something that appears to be more sinister? Look for indications from management on how it plans to stop similar mistakes from happening in the future.
It is also worth remembering that changes in certain financial estimates are not required, as these are based on anticipated events and not ones that have already occurred. These changes must only be reported on the next financial statement after the change is made and are not applied retroactively.
What Is the Difference Between Reclassification and Restatement?
A restatement is the restatement of a revised financial statement. The restatement is purposed to correct what was previously reported erroneously. A reclassification involves correcting the classification of a transaction or entry, moving it from one ledger to another. For example, one could reclassify an entry from a current asset to a long-term asset.
What Is the Difference Between Revision and Restatement?
A revision is the correction of a reported amount in subsequent financial statements. However, the previously reported financial statement need not be reissued. With a restatement, on the other hand, the error must be material, prompting a revision and the issuance of a corrected financial statement.
What Is the Restatement of Torts?
The Restatement of Torts is a resource published by the American Law Institute (ALI) explaining the law as it pertains to certain situations, specifically involving torts. There are two Restatement of Torts: Restatement of the Law Second, Torts, and Restatement of the Law Third, Torts, which is the most recent published version.
What Is the Restatement of Contracts?
The Restatement of Contracts is a resource published by the American Law Institute (ALI) explaining the law as it pertains to contracts. In other words, they help courts clarify and interpret contract law.
The Bottom Line
When financial reports contain material inaccuracies, companies must correct the accounting error and reissue a corrected version of the financial statement. The error could have resulted from oversight, simple mistakes, or something more sinister, such as fraud. Despite the underlying reason, errors can cause those examining the statements to make decisions based on inaccurate data.