Restatement Trends: What Audit Committees Should Know

Restatements occur for numerous reasons, including human error, the misapplication of reporting standards, and fraud, all of which have different associated costs and consequences. Restatement announcements could pertain to audited (annual) or unaudited (quarterly) financial statements, each with different implications for auditor responsibility. Understanding the details of restatement trends may be helpful to audit committees in their role to oversee financial statements.

Several factors, noted below, influence the likelihood of financial misreporting, whether intentional or unintentional.

1.   There are pressures and incentives to report results consistent with objectives. These pressures and incentives include:

• poor or declining operating performance,
• a failure to meet market expectations,
• market manipulation in anticipation of merger and acquisition (M&A) activity,
• the desire to raise new capital, and
• the terms associated with stock-based compensation contracts.

2.   Sometimes, there are failures of internal and external oversight mechanisms, including:

• weaknesses in internal controls over financial reporting,
• insufficient audit committee oversight,
• insufficient executive oversight, and
• deficiencies in auditor effort, independence, or expertise.

3.   There’s ambiguity around financial reporting for certain business activities, including:

• the complexity of financial reporting standards, and
• the complexity of a company’s operations.

According to the Center for Audit Quality’s (CAQ) Financial Restatement Trends in the United States: 2013–2022 report, restatements have continued the downward trend that began in 2006. The study analyzed restatements announced from Jan. 1, 2013, through Dec. 31, 2022. There were a total of 1,352 Item 4.02 (“Big R”) restatements and 4,441 (“little r”) restatements during the period, totaling 5,793 over this decade. Based on this research, the CAQ found that:

• Fraud is implicated in just 3 percent of restatements overall.
• Restatements affecting core earnings, which are considered more severe than restatements that are nonrecurring or affect other components of earnings, make up less than half of restatements overall in all but one year of the study, ranging from 43 percent to 49 percent between 2013 and 2022.
• The number of years restated declined throughout the decade, falling to an average of slightly more than a year by the end of 2022, which suggests that reporting errors are being identified quicker.
• Restatement announcements associated with unaudited, interim financial statements increased throughout the sample period, rising to 50 percent of “Big R” restatements by 2022. This suggests that fewer instances of misreporting are making it through the audit and are instead being identified by internal processes.

Diving into the nature of restatements, audit committees should be aware of the most common underlying causes of these errors in reporting. Business activities drive approximately 70 percent of restatements, including revenue, expenses, taxes, investing, and financing. Financial statement presentations and subsidiary and atypical transactions are other types of restatements but are not as prevalent.

Source: The Center for Audit Quality. (2024). Trends in Business Activities [Figure]. caq-financial-restatement-trends-us-2013-2022_2024-06.pdf

Expenses are the most common driver of business activity restatements. Restatements due to expenses account for more than 50 percent of restatements announced annually. These restatements are caused by errors in accounting for accruals, reserves and estimates, cost of sales, stock-based compensation, depreciation and amortization, contingencies and pensions, and leases.

Source: The Center for Audit Quality. (2024). Expense Restatement Trends [Figure]. caq-financial-restatement-trends-us-2013-2022_2024-06.pdf

The health-care and pharmaceutical industry saw an increase in restatements from a low of 11 percent of restatements announced in 2013 to a high of 20 percent in 2021. Among financial institutions, banks, and insurance companies, restatements increased sharply from 13 percent of restatements announced in 2020 to 22 percent in 2022.

It is possible that the complex accounting issues associated with M&A are driving the upward trend in restatements announced by the healthcare and pharmaceutical industry. McKinsey & Co. noted a 13 percent annual increase in M&A activity across the life sciences sector from 2011 to 2021 in the article, “Life Sciences M&A Shows New Signs of Life.” In the financial sector, macroeconomic pressures (i.e., market volatility and inflationary pressures) could be driving restatements.

It is also worth noting that Nasdaq-listed companies have contributed more than other public companies to the restatement population from 2013 to 2022.

While the restatement trend between 2013 and 2022 was relatively stable and even decreased for companies trading on the New York Stock Exchange (NYSE), the percentage of total annual restatement events increased sharply to 55 percent for Nasdaq-listed companies in 2022. It is true that Nasdaq is often home to younger, more growth-oriented technology companies compared to the larger, more established companies listed on the NYSE. However, the reason for this trend is unknown. Therefore, the audit committees of Nasdaq-listed companies may do well to take a closer look at the restatement trends of peers and competitors for any specific risk factors.

Observing past trends may be helpful to audit committees in the performance of their oversight duties. Through awareness of the industries and financial statement areas more commonly associated with restatements, audit committees can increase scrutiny appropriately.

CAQ is a NACD partner, providing directors with critical and timely information, and perspectives. CAQ is a financial supporter of the NACD.

Vanessa Teitelbaum, CPA, is senior director on the Professional Practice team at the Center for Audit Quality. She joined the CAQ in 2016 and advocates for stakeholders in the audits of public companies.