Restatement Meaning
A restatement is the revision of already issued financial statements pertaining to one or more companies to correct errors with material inaccuracy happened as a result of non adhering and complying with the General Accepted Accounting Policies (GAAP), accounting mistakes, fraud or clerical errors and affecting part of the total financial statement which may require a completely new audit which may impact the future financial statements as well.
The issuance of restated financial statements is necessary so that the stakeholders get the correct picture of the company and make their decision making accordingly. It is also essential to report the errors and consider them in the statement if they are material.
Examples of Restatement
Molson Coors Brewing Company intimated its stakeholders in February 2019 that it would be issuing restatement of the financial year 2016 and 2017. The auditors discovered material discrepancies in respect of deferred tax liabilities for income tax. The company understated income tax expense and deferred tax liability.
source: Molson Coors Brewing Company SEC Filings
It resulted in falsely increasing the net profit by $400 million for the year 2016. Later the company accepted that it had understated the tax amount yet to be paid in its balance sheet by $248 million. The equity valuation of the company got overstated by an equal amount. The company share price fell by nearly 6.4% upon its disclosure.
Types of Restatement
Based on errors level, we can classify the restatement statement into the following categories:
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Step #1 – Non-Reliance Restatement
It is issued when there are mass errors found in the earlier period statements and thus making it tough to rely on the previous as well as current financial statements. An 8K item 4.02 has to be filed, and the opinion by auditors must refer to it. It is also called a re-issuance statement.
Step #2 – Revision Restatement
It is issued when there is a material error in the past financial statement, but the degree of error is not undermining the credibility of financial statements of another period. Only the past financial statement is required to be restated. Unlike non-reliance restatement, item 4.02 is not necessary.
Step #3 – Out of Period Adjustments
If the degree of error is not that much to affect the reliability of any period’s financial statement, then it doesn’t require any restatement. Its effect can be taken collectively by incorporating the same in the current financial statement along with a disclosure note for it as it will affect the comparability.
Restatement Rule
As per the GAAP the following three types of errors if found material has to be corrected and a restatement to be issued:
- Accounting Error
- Non-Complying with GAAP
- Fraud or Misrepresentation
If any of the above errors are found then, it has to pass the materiality test. Materiality is judged by analysing whether the error found will significantly impact the stakeholders in their decision making or not. Not all errors need to be restarted by issuing restatements to its users. Apart from the factor of significant errors, there can be other causes as well, which may require restatement. These are:
- Changes in GAAP: If any change in respect of accounting methods which may be required in the current financial statement and if applied retrospectively would impact the prior period statement as well, the comparison statement needs to be restarted.
- Changes of Reporting Entity: If the ownership type or structure of any company is changed in the current period and it has a significant impact in reporting or disclosure pertaining to the financial statement, the comparative statement of the prior periods needs to be restarted.
Impact
The impact of restatement may vary depending on the level and degree of errors. It is observed in the past that the market responds more harshly to the re-issuance statement as compared to the revision statement. Its cause also decides the market sentiments. If it is issued because of integrity or operational issues, the stakeholder’s trust is hit harder. Apart from all these restatements generally result in higher audit fees as the auditor has to spend extended hours to analyse the impact and nature of restatement to ensure that the audit quality is high.
Prevention
The restatement may undermine the company valuations or exhaust the accounting or legal resources and may dilute the company’s image in front of its stakeholders. We must take preventions to avoid any nightmare because of issuing restatement:
- Engage qualified and smart accounting professionals.
- Implement strong and effective internal controls within the organization;
- Exhibit a culture of conservatism and integrity.
Risks
- Impact the goodwill of the company;
- Undermine the valuation of the company;
- Decrease the credibility of the company;
- Limit the funding to the company;
- Hamper the operation of the company;
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