A new Treasury-sponsored study on financial restatements found that there was a significant increase in restatements by 2005 accelerated filers during the 2003-2005 implementation period for internal controls reporting under section 404 of the Sarbanes-Oxley Act. The study also found that restatements associated with fraud and revenue declined after 2001. Fraud was a factor in 29 percent of all 1997 restatements, the study found, but only 2 percent of 2006 restatements. The proportion of revenue-related restatements also decreased from 41percent in 1997 to 11 percent in 2006. Not surprisingly, market reaction to financial restatements tended to be more negative when the restatement involved fraud or revenue errors.
The study, conducted by University of Kansas Professor Susan Scholz, provides one of the most in-depth looks at the soaring number of financial restatements in the years before and after the Sarbanes-Oxley Act. Treasury did not ask the study's author to develop policy recommendations. Rather, the study was intended to inform federal regulators and advisory committees, such as the SEC's Advisory Committee on Improvements to Financial Reporting.
Broadly, the study found that the enactment of Sarbanes-Oxley affected restatement activity in several ways. For example, section 302 required senior executive and financial officers to provide formal assurance that internal controls were adequate and that the financial statements were fairly presented. Combined with section 404 reporting on the effectiveness of internal controls, the focus on internal control attestation and reporting appears to have increased restatements announced during the 2003-2005 section 404 implementation period.
Beginning with financial statements for fiscal years ending on or after November 15, 2004, section 404 regulations required U.S. accelerated filers to document, test and report on internal controls over financial reporting (ICFR). Auditors were also required to attest to management’s internal controls assertions. Efforts to implement these requirements began as early as 2003, intensifying in 2004 and culminating in the first ICFR reports in early 2005. Implementation of ICFR processes sometimes identified ongoing misstatements.
The study also found that another factor increasing the attention on financial reporting quality was the establishment of the PCAOB as the public company auditor regulator with an inspection process and enforcement authority.
The study drilled down into restatements by companies that were accelerated filers mandated to report on the effectiveness of internal controls under section 404. There was a significant increase in restatements by 2005 accelerated filers during the 2003-2005 ICFR implementation period. During this time, accelerated filers announced 47 percent of restatements. In contrast, in the pre-2003 period, companies destined to be classified as accelerated filers for 2005 were responsible for 33 per cent of all restatements. The percentage drops to 40 per cent in 2006
Although some accelerated filers would have announced restatements absent ICFR implementation, said the report, nearly a quarter of all 4,923 restatements (1997-2006) wee made by 2005 accelerated filers during ICFR implementation (2003- 2005).
Data indicated that about 3,700 companies issued ICFR reports in the first year of required reporting. This suggests that approximately 31 per cent (1,156 of 3,700) of accelerated filers restated their financial reports over the three-year period.
But not all restating accelerated filers reported ineffective controls. Of the 349 accelerated filers restating in 2004, only 137 reported ineffective controls in their initial report for fiscal year end 2004, typically filed in early 2005. Of the 527 companies announcing restatements in 2005, 263 initially reported ineffective controls. This count was later revised upward, presumably because companies later discovered misstatements.
The study, conducted by University of Kansas Professor Susan Scholz, provides one of the most in-depth looks at the soaring number of financial restatements in the years before and after the Sarbanes-Oxley Act. Treasury did not ask the study's author to develop policy recommendations. Rather, the study was intended to inform federal regulators and advisory committees, such as the SEC's Advisory Committee on Improvements to Financial Reporting.
Broadly, the study found that the enactment of Sarbanes-Oxley affected restatement activity in several ways. For example, section 302 required senior executive and financial officers to provide formal assurance that internal controls were adequate and that the financial statements were fairly presented. Combined with section 404 reporting on the effectiveness of internal controls, the focus on internal control attestation and reporting appears to have increased restatements announced during the 2003-2005 section 404 implementation period.
Beginning with financial statements for fiscal years ending on or after November 15, 2004, section 404 regulations required U.S. accelerated filers to document, test and report on internal controls over financial reporting (ICFR). Auditors were also required to attest to management’s internal controls assertions. Efforts to implement these requirements began as early as 2003, intensifying in 2004 and culminating in the first ICFR reports in early 2005. Implementation of ICFR processes sometimes identified ongoing misstatements.
The study also found that another factor increasing the attention on financial reporting quality was the establishment of the PCAOB as the public company auditor regulator with an inspection process and enforcement authority.
The study drilled down into restatements by companies that were accelerated filers mandated to report on the effectiveness of internal controls under section 404. There was a significant increase in restatements by 2005 accelerated filers during the 2003-2005 ICFR implementation period. During this time, accelerated filers announced 47 percent of restatements. In contrast, in the pre-2003 period, companies destined to be classified as accelerated filers for 2005 were responsible for 33 per cent of all restatements. The percentage drops to 40 per cent in 2006
Although some accelerated filers would have announced restatements absent ICFR implementation, said the report, nearly a quarter of all 4,923 restatements (1997-2006) wee made by 2005 accelerated filers during ICFR implementation (2003- 2005).
Data indicated that about 3,700 companies issued ICFR reports in the first year of required reporting. This suggests that approximately 31 per cent (1,156 of 3,700) of accelerated filers restated their financial reports over the three-year period.
But not all restating accelerated filers reported ineffective controls. Of the 349 accelerated filers restating in 2004, only 137 reported ineffective controls in their initial report for fiscal year end 2004, typically filed in early 2005. Of the 527 companies announcing restatements in 2005, 263 initially reported ineffective controls. This count was later revised upward, presumably because companies later discovered misstatements.