Study shows fewer and less severe restatements over decade post-SOX

by Cydney Posner

Apparently, SOX had some a beneficial impact on financial reporting.  An academic study commissioned by the Center for Audit Quality reveals a substantial decline in both the number and severity of financial restatements during the period 2003 through 2012. The study was intended to consider the impact on restatements of SOX and related regulatory developments, including SOX 404 (internal control over financial reporting) and the requirement to file Item 4.02 8-Ks, as well as new auditing standards. The study also highlights the differences between those restatements reported on under Item 4.02, that is, restatements that were so severe that the previously filed financial statements and audit report could no longer be relied upon, and non-Item 4.02 restatements.  The study looked at over 10,000 restatements (defined as corrections of errors in public company GAAP financial statements filed with the SEC), over 6,000 of which were not reported under 4.02. There were 6,800 unique filers studied; one filer announced 10 restatements over the period. Yikes. Among the study’s key findings:

  • The number of restatement announcements peaked at 1,784 in 2006, soon after implementation of SOX 404 internal control reporting, and subsequently declined rapidly.
  • The total decline is primarily attributable to a “precipitous drop in the number of 4.02 restatements,” from almost 1,000 in 2005 to 255 in 2012.
  • The average number of accounting issues underlying each restatement declined steadily after 2005, with multiple issues reported for 70% of restatements in 2005, but for only 28% of 2012 restatements.
  • By industry, Computer & Software (18% of restatements), Financial, Banking & Insurance (16%), and Energy, Mining & Chemicals (14%) rank among the top three industries for restatements over the period.
  • In later years, fewer restatements involved the most serious issues, such as revenue recognition, decreasing from 65% of restatements in 2005 to 41% in 2012.
  • In later years, restatements covered shorter periods of time, declining from an average of more than two years in 2005 to less than a year and a half in 2012.
  • In later years, fewer restatements reduce previously reported income, declining from 61% of restatements in 2005 to 36% in 2012.
  • Fraud as a factor appears to be de minimis at only 2% across the decade, but, for various reasons, this data may not be entirely reliable.
  • In later years, companies announcing restatements tended to be smaller ($1.3 billion in total assets in 2011, down from $7.9 billion in 2006).
  • Throughout the decade, most restatement companies were unprofitable. (Exception: financial institutions in 2012.)
  • About half of all restatement companies reported a net loss prior to announcing the restatement.
  • Over the decade, the average stock price reaction to restatements was -1.5% (adjusted for the overall market return), with reactions to 4.02 restatements averaging -2.3%, compared to -0.6% for non-4.02 restatements, and reactions to restatements involving revenue and fraud averaging -4.0% and -6.8%, respectively.

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