How World-Class Organizations Are Safeguarding Against the Current Rise in Financial Restatements

Blog post

Over the past decade, audit fees have grown drastically, climbing from $7.2 billion in 2010 to $9.3 billion in 2018. Organizations are now spending more than they ever have to ensure that publicly stated financials are as error-free as possible.1 Despite this, there was an almost 10% increase in companies that reported a material misstatement between 2017 and 2018.2 When you combine those companies with the companies that make a non-material correction to a past financial statement, you find that almost 6% of public companies issued some kind of correction to their financial statements within a one-year time frame.3

As the office of finance continues to grow in both complexity and size, all of these numbers are likely to grow in tandem. To understand how to protect the office of finance from restatements in the coming years, it’s important to distinguish what types of restatements there are, what they mean for the office of finance as far as responsibilities and impact, and how to best prevent those restatements.

“Big R” Restatements

The “Big R” restatements, also known as reissue restatements, are the types of restatements that people are most familiar with, and are one of the worst things that can happen to the office of finance. When organizations find material weaknesses, they’re required to restate previously issued financial statements to correct their errors. Additionally, when this occurs, the auditor’s opinion is also changed to disclose the restatement.

Because of the size of “Big R” restatements and the associated errors, the exact reasoning for these misstatements can vary widely. But no matter what the specific issue is, any possible reason will show a material weakness in a company’s internal controls and translate into significant fines, loss in revenue and decreased investor confidence.

“little r” Restatements

Occasionally, organizations will discover an error after closing their books that will not be material to prior financial statements. While these errors may be immaterial to each individual year, they will eventually build over time to become a material amount that will have a more serious impact on the balance sheet. In order to prevent these issues from growing into a larger problem, companies will restate prior period information in the current period financial statements. This is known as a revision restatement and commonly referred to as a “little r” restatement. During these “little r” restatements, organizations still disclose the correction in the footnotes of the current period financial statements, but do not have to amend any former filings. Additionally, a “little r” restatement does not require the auditor(s) that worked on the prior period financial statement to modify their opinion of the previous financial statements.

Because of the perceived lack of consequences when compared to organizations with a material weakness, “little r” restatements are not taken as seriously and easily fly under the radar for investors. However, these restatements often result from deficiencies in internal controls or a lack of standardized processes. Despite not having a material impact on the current balance sheet, “little r” restatements still pose a serious risk to the future of the company as they could have easily resulted in a larger restatement if certain circumstances had changed or if the error went undetected and became more impactful over time.

How Organizations Can Mitigate Financial Risk

If trends continue, the office of finance will be forced to spend more than ever on audits, while struggling to produce reliable financial statements. In order to protect against the rise in restatements, organizations need to identify ways to spend less on auditing their process and invest more into resources which fix the process itself.
Today, best-in-class organizations are successfully mitigating risk by automating their compliance process. With a focus on effectively streamlining, Cadency Compliance enables the automation and documentation of corporate and regulatory compliance by implementing your financial governance model throughout the entire Record to Report (R2R) process. Additionally, by utilizing your critical controls, issues are flagged as soon as they arise, and the solution creates a centralized record of multiple compliance initiatives. Ultimately, this approach not only improves visibility and insight into the compliance process, but reduces the time and resources needed to support external audits.

To learn more about how an automated compliance solution can benefit your company’s office of finance, read our white paper.

Written by: Caleb Walter and James Lawrence

[1] Hallas, N. Mckeon, J. (December 24, 2019). “Seventeen Year Review of Audit Fee and Non-Audit Fee Trends.” Retrieved March 2, 2020, Audit Analytics

[2] Mohan, N. (September 20, 2018). “Companies Are Finding More Accounting Flubs.” Retrieved March 2, 2020, Wall Street Journal

[3] Whitehouse, T. (Aug 26, 2019) “Revenue recognition drove 2018 restatements, new report says”. Retrieved March 2, 2020, Compliance Week