In the first half of 2021, there was a surge in financial restatements. The reason relates to guidance issued by the Securities and Exchange Commission, requiring special purpose acquisition companies (SPACs) to report warrants as liabilities. SPACs are shell corporations that are listed on a stock exchange with the purpose of acquiring a private company, thereby making it public without going through the traditional initial public offering (IPO) process. Historically, SPACs that offer warrants (which allow investors to buy shares at a set price in the future) have reported those instruments as equity.
In this situation, most SPAC investors understood that these restatements were related to a financial reporting technicality that applied to the sector at large, rather than problems with a particular company or transaction. But some restatements are not so innocuous.
Close-Up on Restatements
The Financial Accounting Standards Board defines a restatement as a revision of a previously issued financial statement to correct an error. Whether they are publicly traded or privately held, businesses may reissue their financial statements for several ‘mundane’ reasons. Like the recent situation with SPACs, managers might have misinterpreted the accounting standards, or they simply may have made minor mistakes and need to correct them.
Leading causes for restatements include:
- Recognition errors (for example, when accounting for leases or reporting compensation expense from backdated stock options)
- Income statement and balance sheet misclassifications (for instance, a company may need to shift cash flows between investing, financing, and operating on the statement of cash flows)
- Mistakes reporting equity transactions (such as improper accounting for business combinations and convertible securities)
- Valuation errors related to common stock issuances
- Preferred stock errors
- The complex rules related to acquisitions, investments, revenue recognition, and tax accounting
Reasons to Restate Results
Often, restatements happen when the company’s financial statements are subjected to a higher level of scrutiny. For example, restatements may occur when a private company converts from compiled financial statements to audited financial statements, decides to file for an IPO, or merges with a SPAC. Restatements also may be needed when the owner brings in additional internal (or external) accounting expertise, such as a new controller or audit firm.
In some cases, a financial restatement also can be a sign of incompetence, weak internal controls, or even fraud. Such restatements may signal problems that require corrective actions.
We Can Help
The restatement process can be time consuming and costly. Regular communication with interested parties, including lenders and investors, can help businesses overcome the negative stigma associated with restatements. Management also needs to reassure stakeholders that the company is in sound financial shape to ensure their continued support.
We can help accounting personnel understand the evolving accounting and tax rules to reduce the risk of restatement. Our staff also can help them effectively manage the restatement process and take corrective actions to reduce the risk of restatement going forward.