Norman Marks on Governance, Risk Management, and Internal Audit

Every so often, the firm of Audit Analytics shares a report with information of interest.

Their latest is 2021 Financial Restatements: A Twenty-One-Year Review. They introduce it:

In this report, we cover twenty-one years of trends in financial restatements – including a closer look at the effect of SPACs on recent trends in financial restatements. We also cover materiality, impacts, severity measures, size and location, and the top accounting issues.

If you are involved in preparing or auditing financial statements or the system of internal control over financial reporting (e.g., for SOX compliance), or on the audit committee of the board, you should read the report.

The big news is that the great majority of restatements were due to issues around the use and accounting for special purpose acquisition companies (SPACs). As the report says:

On April 12, 2021, the SEC’s Acting Director of the Division of Corporation Finance John Coates and Acting Chief Accountant Paul Munter issued a joint statement urging companies with warrants issued by Special Purpose Acquisition Companies (SPACs) to reconsider the accounting treatment of those warrants.3 In November, hundreds of SPACs reclassified redeemable shares from permanent equity to temporary equity.

The SEC’s guidance on accounting for redeemable shares and warrant liabilities resulted in significant increases observed in both the number of restatements filed and the number of companies that disclosed a restatement during 2021. Additionally, the composition of restating companies was altered from previous years, as these two accounting issues had a broad impact on a narrow population: SPACs and companies acquired by SPACs.

As a direct result, the positive trend in the number of restatements was interrupted in 2021. If you exclude SPAC-related restatements, the numbers continued to decline.

If you exclude SPAC-related restatements, the more significant accounting issues were:

• Debt and equity securities – 19.1%
• Revenue recognition – 12%
• Liabilities and accruals – 11.7%
• Expenses – 10.9%
• Taxes – 8.8%
• Cash flows – 7.3%
• Share-based compensation – 7%
• Acquisitions and divestitures – 7%
• Inventories – 6.7%
• Asset valuations – 6.5%

I find it interesting that a hot button in previous years, Revenue Recognition, has dropped from being the reason behind more than 20% of restatements in 2004, around 16% in 2018, to 12% last year.

What does all of this mean for those of us involved in preparing or auditing financial statements and related controls?

I believe this should be factored into your risk assessment activities.

The audit committee might include a discussion of this report with their external auditors.

I welcome your thoughts.