Of these, annual statements got particular scrutiny in 2002. The number of restated audited annual financial statements rose to a record high of 183, representing 55% of the total filed during the year and an increase of 43 audited annual restatements, or 31%, from 2001, research from the Huron Consulting Group revealed.
Huron’s study focused on restatements of both quarterly (10Q) and annual (10K) financial statements that had been previously filed with the US Securities and Exchange Commission (SEC). The study is then broken down by company size and industries. Huron says these numbers were significantly impacted by two major events: the passage of the Sarbanes-Oxley Act of 2002 and the closing of Arthur Andersen’s audit practice.
Larger companies reported a majority of the accounting problems in 2002. The number of restatements by companies with annual revenues of $100 million or greater rose to 190, or 58% of all restatements filed during the year. This signifies a shift from 2001, in which companies with annual revenues under $100 million filed the majority of restatements. More significant is that the number of restatements during 2002 by companies with annual revenues greater than $1 billion escalated to 74 restatements, or 22% of all restatements filed during 2002.
By industry, the three industries that experienced the largest increase in restatements in 2002 were:
- wholesale and retail trade industry, 95%
- transportation, communications, electric, gas and sanitary services industry, 45%
- services industry, 19%
However, when comparing the industry restatement share to its market share of public companies, these three industries have experienced a restatement share over the past five years that is less than or equal to its market share as of December 2002. Restatements filed over the past five years have largely been by companies in the manufacturing industry, the software industry, and the finance, insurance and real estate industry, Huron’s research shows.
Revenue recognition, instances where a company improperly recognizes revenue of transactions, was the issue in 85 of the restatements filed in 2002. The 85 in 2002 represents an increase of 73% from 2001, as revenue recognition continues to be the leading cause of restatements across most industries falling in the number one or number two spot for all but two industries. Other issues causing many of the restatements include:
- acquisition accounting
- capitalization/expense of assets
Events of 2002
Huron points to the passage of the Sarbanes-Oxley legislation as having a major impact because of the establishment of new accounting/auditing rules and the delivery of a strong public message regarding the need for improvements in the system of financial reporting. Evidence of this is the number of restatements filed in the five months after the enactment of Sarbanes-Oxley on July 30, 2002.
Following the measure’s passage, restatements were disproportionately higher than the restatements during the first seven months of the year, and likewise as compared to the same five-month period in 2000 and 2001. In 2002, 145 restatements were filed before the passage of the legislation and 185 restatements were filed afterwards.
Additionally, Huron says Arthur Andersen closing up its audit shop gave rise to an increase in restatements. This move caused approximately 1,300 US public companies to engage new audit firms, thereby forcing a partial form of auditor rotation.