Background of Financial Restatements

Someone looking at a computer and talking on the phone

In the first half of 2021, there was a surge in restating financial statements. 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 listed on a stock exchange to acquire a private company, making it public without going through the traditional IPO process. Historically, SPACs that offer warrants (which allow investors 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, rather than problems with a particular company or transaction. But some restatements aren’t so innocuous.

What are restated financial statements?

The Financial Accounting Standards Board (FASB) defines a restatement as revising a previously issued financial statement to correct an error. Businesses may reissue their financial statements for several “mundane” reasons, whether publicly traded or privately held. Like the recent situation with SPACs, managers might have misinterpreted the accounting standards or made minor mistakes and need to correct them.

Leading causes for restatements

  • 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 in reporting equity transactions (such as improper accounting for business combinations and convertible securities),
  • Valuation errors related to common stock issuances,
  • Preferred stock errors, and
  • The complex rules related to acquisitions, investments, revenue recognition, and tax accounting.

Example of reasons to restate results

Often, restatements happen when the company’s financial statements are subjected to higher scrutiny. For example, restatements may occur when a private company converts from compiled financial statements to audited financial statements, decide to file for an initial public offering — 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, financial restatements also can be a sign of incompetence, weak internal controls — or even fraud. Such restatements may signal problems that require corrective actions.

Communication is key

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 must also reassure stakeholders that the company is financially sound to ensure their continued support.

We can help with your financial restatements

We can help accounting personnel understand the evolving accounting and tax rules to minimize the risk of financial restatements. We can also help them effectively manage the restatement process and take corrective actions to minimize the risk of financial restatements going forward.

© 2023