Statement Restatements Research Articles

Accounting, Legal and Tax Difficulties Concerning the Applying of IFRS Entities Listed on Capital Market

The objectives of this article is to analyze the accounting, legal and tax difficulties resulting from the application of International Financial Reporting Standards entities listed on the stock market, resulting from the restatement of financial statements for the last three years as a divergence between national1 and international standard. EU implementation of IFRS and therefore we require audits of financial statements for entities whose securities are traded on the stock exchange. Accounting in Romania has undergone many challenges arising from the harmonization and compliance with European directives and inter- national standards. The cost-benefit of applying IFRS is not insignificant indicator for governance and management, and ac- counting professionals must face a new challenge, in which the judgment of value judgments is a criterion that is present throughout the require restatement of assets, liabilities, equity, expenses and income as a basis for comparison to IFRS. The accounting, judicial and fiscal impact is a regulatory problem of the Romanian authorities and did not hesitate to appear.

Exploring the Effects of Inflation on Financial Statements Through Ratio Analysis

The article explores the effects of inflation on financial statements. Inflation, even at lower rates affects financial statements. International Accounting Standard 29 “Financial Reporting in Hyperinflationary Economies-IAS 29” imposes some percentage criteria as to the restatement of financial statements. This criteria-an inflation rate for restatement of financial statements can be set as minimum as possible, because inflation adjustments change the figures even at lower inflation rates. As the inflation accelerates the effects of inflation become more apparent on financial statements. A model company has been developed and gradual increases in inflation rates have been tried on the model. Model shows that even at lower rates, the inflation negatively affects financial statements. Model shows what ratios are affected by inflation adjustments. Article proposes that inflation adjustments to financial statement should be a continuous issue and should be consistently applied to financial statements even at lower rates than required by IAS 29.

Exploring the Risk of Overstatements and Understatements in Financial Reporting Due to Inflation and Devaluation Gaps

This article explores the effects of gaps between inflation and devaluation on financial statements in economies. A model company, an assumed subsidiary of a US parent, is used for reporting to the parent based on current International Financial Reporting Standards (IFRS). The model company reported to its parent on different assumed inflation and devaluation rates, and the results are discussed and discrepancies explained. The article suggests that financial statements are distorted in an economy as the current IAS 29 does not require any restatement of the financial statements until the cumulative inflation rate for the last three years is around 100%. The paper explores the premise that restatement of financial statements on local currencies based on IAS 29 at lower inflation rates before conversion to the reporting currency should be considered as a solution to solve the distortions in financial reporting for multinational companies.

Bringing Darkness to Light: The Influence of Auditor Quality and Audit Committee Expertise on the Timeliness of Financial Statement Restatement Disclosures

SUMMARY:This study investigates whether auditor quality and audit committee expertise are associated with improved financial reporting timeliness as measured by the duration of a financial statement restatement's “dark period.” The restatement dark period represents the length of time between a company's discovery that it will need to restate financial data and the subsequent disclosure of the restatement's effect on earnings. For a sample of dark restatements disclosed between 2004 and 2009, we find that companies that engage Big 4 auditors have shorter dark periods than companies that do not engage Big 4 auditors. We also find that companies with more financial experts on the audit committee have shorter dark periods, but only when such financial expertise relates specifically to accounting. Finally, companies with audit committee chairs that have accounting financial expertise provide the most timely disclosures, as the dark periods for these firms are reduced by approximately 38 percent. Our results suggest that both auditor and audit committee expertise are associated with the timely disclosure of restatement details.Data Availability: All data are publicly available from sources identified in the paper.

Corporate Governance Changes Following Reputational Damage in the Financial Industry

In this paper, we empirically study the motives and consequences of corporate governance changes following possible causes of reputational damage in the financial industry. To do so, we present a comprehensive analysis of the causes and effects of changes in the top management position (i.e., the CEO), the board composition (i.e., non-CEO executive directors, independent directors and board size), and the board activity (i.e., the frequency of board meetings) following 26 income-decreasing financial statement restatement announcements and 294 large operational loss announcements (i.e., of at least $10 million in value) in 75 U.S. financial firms from 1995 to 2009. First, in consistence with literature, an event study analysis shows that internal fraud announcements cause the most severe reputational damage to the loss firms followed by lower and similar reputational damages of restatement and other event announcements (i.e., all internally-caused operational loss announcements except for internal fraud announcements) with no reputational effect of external fraud announcements. Second, our results show that restatement announcements are associated with a higher probability of the CEO turnover by the end of the announcement year, less incoming executive directors, more outgoing independent directors, less change in board size and an enhancement in board activity. Additionally, internal fraud announcements are more probably to cause the CEO to leave out his position only in the next fiscal year (for higher losses) and cause more incumbent executive directors to quit the board and less new independent directors to be hired to the board thus leading to a reduction in the board size. Also, higher other event loss amounts might enforce the CEO to resign and motivate the board to enhance its activity. Although they cause no reputational damage, external fraud announcements are associated with less outgoing independent directors and less incoming executive directors. Finally, we employ the ex post market-adjusted stock performance as a measure of stakeholders’ trust following corporate governance changes in loss firms. Interestingly, our results suggest that equity market participants (i.e., potential investors) trust more financial firms that decrease the presence of non-CEO executive directors following restatement and internal fraud announcements, financial firms that increase the presence of independent directors on their boards following internal fraud announcements and financial firms that enhance their board activities following restatement and other event announcements while they suspect financial firms that immediately change their CEOs following other event and external fraud announcements. All in all, our paper contributes toward a better understanding of the reasoning that governs the decisions and actions of shareholders and boards with respect to enhancing corporate governance mechanisms following reputational damage in the financial industry and how the market responds to the signals involved in such decisions and actions.

Earnings informativeness after financial statement restatements

Financial restatements may affect core earnings if the restatements involve revenue, cost of sales or ongoing expenses. Hence, restatements may impact information content of earnings. Using the earnings response coefficient (ERC) as a measure of the information content of earnings, we document a decline in ERCs in several quarters following the announcement of restatements. The decline in ERCs is especially evident in restatements that are unattributed to any source or attributed to the company, classified as fraud or no fraud, affect multiple accounts (pervasive) and more than one year. Overall, our results suggest that restatements that are especially severe cause investors to lose confidence in reported earnings and that these effects may persist for several quarters beyond the restatement.

Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees

ABSTRACTThis study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001–2007 as an indicator for audit failure, I find that the amount of NAS fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.Data Availability: All data are publicly available from sources identified in the study.

Abnormal Audit Fees and Restatements

SUMMARY We investigate the relationship between audit fees and subsequent financial statement restatements in the years following the Sarbanes-Oxley Act of 2002 (SOX). After controlling for internal control quality, we find that abnormal audit fees are negatively associated with the likelihood that financial statements are subsequently restated. This result conflicts with prior work that finds that audit fees are positively associated with future restatements. Overall, our evidence is consistent with the notion that restatements reflect low audit effort or underestimated audit risk in the periods leading up to the restatement year.

Tax-Related Financial Statement Restatements and Auditor-Provided Tax Services

In this study, the authors investigate the association between auditor-provided nonaudit tax services (NATS) and financial reporting quality for public companies in a post-Sarbanes-Oxley environment. They measure the quality of financial reporting by means of appropriately screened financial statement restatements. The Sarbanes-Oxley Act of 2002 (SOX) restricts the scope of auditor-provided tax services and simultaneously bans other major nonaudit services by the auditor. The authors argue that the restriction limits the potential financial reporting quality benefits of NATS, while the ban simultaneously makes those services a relatively more important source of revenue to the auditor, exacerbating the potential for impairment of independence. Consequently, pre-Sarbanes-Oxley results may not hold in a post-Sarbanes-Oxley environment. On examination, they find no significant association between auditor-provided NATS and general financial statement restatements. However, they find a significant negative association between such services and tax-related financial statement restatements. Thus, in a post-Sarbanes-Oxley environment, the benefits of auditor-provided NATS seem to manifest themselves in higher quality tax-related financial statement management assertions.

Target Financial Reporting Quality and M&A Deals That Go Bust

This study investigates the role of financial reporting quality in merger and acquisition (M&A) deals that are ultimately terminated, i.e., go bust. If a target is a U.S. publicly-traded company, an acquirer’s initial assessment of the potential benefits associated with the acquisition of the company is based on publicly available information. Generally, the acquirer obtains limited private information from the target prior to announcing the deal, but engages in transactional due diligence after signing the acquisition agreement to affirm that the financial reporting warranties made by the target are accurate. We construct a low quality financial reporting score based on measures prior research identifies as being associated with less-reliable, less-relevant, and less-precise financial reporting. We find that acquirers offer higher premiums for targets with low quality financial reporting. However, we also find that low quality financial reporting increases the likelihood of deal renegotiation, and contributes to the probability of deals going bust. We document that failed targets are more likely to restate their financial statements after the announcement of the deal, supporting our conjecture that low quality financial reporting contributes to deals being terminated. Our research provides new insights into the capital market consequences of financial reporting quality and identifies a new determinant of financial statement restatements.

Is There Transparency In Auditor Change Disclosures?

<p class="MsoNormal" style="text-align: justify; margin: 0in 31.2pt 0pt 0.5in;"><span style="font-family: Times New Roman;"><span style="font-size: 10pt; mso-bidi-font-size: 12.0pt; mso-bidi-font-style: italic;">In this paper, we examine the reasons disclosed in a small representative sample of Form 8-Ks for switching auditors. We classify auditor switches in terms of changes from big-4 to other big-4, big-4 to non-big-4, non-big-4 to big-4 and non-big-4 to non-big-4. Our primary objective is to assess compliance with the required disclosures for auditor changes and to reflect on the implications for corporate governance. This line of research is important in light of the requirements of SEC Regulation S-K 304 and recent calls for greater transparency in financial reporting, particularly after Sarbanes-Oxley.<span style="mso-spacerun: yes;">  </span>Our research shows that companies use boilerplate language and adopt a check-the-box approach to compliance with Regulation S-K 304. Contrary to the spirit and intent of corporate governance, their disclosures generally lack transparency and offer little or no insight into the underlying reasons for auditor changes. One of the clearest patterns is that several auditor changes are preceded by such reportable events as going concern uncertainties and material internal control deficiencies that often lead to financial statement restatements. Even so, many companies are less than forthright in the language used to disclose such events. Thus, we conclude that the implied objective of auditor change regulations is not being fulfilled.<span style="mso-spacerun: yes;">  </span>In general, neither auditors nor clients appear to take the auditor change disclosure requirements seriously. It is vital that the PCAOB, SEC, and the audit committees take note of this weakness in auditor change regulation.</span><strong style="mso-bidi-font-weight: normal;"><span style="font-size: 10pt; mso-bidi-font-size: 12.0pt;"> </span></strong></span></p>

Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees

This study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001 – 2007 as an indicator for audit failure, I find that the amount of nonaudit (NAS) fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.

Bringing Darkness to Light: The Influence of Auditor Quality and Audit Committee Expertise on the Timeliness of Financial Statement Restatement Disclosures

This study investigates whether auditor quality and audit committee expertise are associated with improved financial disclosure timeliness as measured by the duration of a financial statement restatement’s “dark period.” The restatement dark period represents the length of time between a company’s discovery that it will need to restate financial data and the subsequent disclosure of the restatement’s effect on earnings. For a sample of dark restatements disclosed during 2004–2009, we find that companies that engage Big 4 auditors have shorter dark periods than companies that do not engage Big 4 auditors. We also find that companies with more financial experts on the audit committee have shorter dark periods, particularly when such financial expertise relates specifically to accounting. Finally, companies with audit committee chairs that have accounting financial expertise have the greatest improvement in disclosure timeliness, as the dark periods for these firms are reduced by roughly 50%. Our results suggest that both auditor and audit committee expertise are important in facilitating the timely disclosure of restatement details.

Tax-Related Financial Statement Restatements and Auditor-Provided Tax Services

In this study we investigate the association between auditor-provided nonaudit tax services and financial reporting quality for public companies in a post Sarbanes-Oxley environment. We measure the quality of financial reporting by means of appropriately screened financial statement restatements. The Sarbanes-Oxley Act of 2002 restricts the scope of auditor-provided tax services and simultaneously bans other major nonaudit services by the auditor. We argue that the restriction limits the potential financial reporting quality benefits of nonaudit tax services while the ban simultaneously makes those services a relatively more important source of revenue to the auditor, exacerbating the potential for impairment of independence. Consequently, pre-Sarbanes-Oxley results may not hold in a post-Sarbanes-Oxley environment. Upon examination, we find no significant association between auditor-provided nonaudit tax services and general financial statement restatements. However, we find a significant negative association between such services and tax-related financial statement restatements. Thus, in a post-Sarbanes Oxley environment, the benefits of auditor-provided nonaudit tax services seem to manifest themselves in higher quality tax-related financial statement management assertions.

Board meetings, committee structure, and firm value

In this study, we examine the determinants of board monitoring activity and its impact on firm value for a broad panel of firms over a six-year period from 1999 to 2005. During this period, Congress and the exchanges promulgated regulations that increased pressure upon firms for more independent and active boards. Economists have debated whether board activity and externally imposed regulations benefit or harm firms. We develop and examine several proxies for board monitoring and examine the relationship between board monitoring activity, firm characteristics, and firm value in a structural equation framework. One set of our proxies is based on the number of annual board and Audit Committee meetings. We show that prior performance, firm characteristics and governance characteristics are important determinants of board activity. We also show that the board monitoring is driven by corporate events, such as an acquisition or a restatement of financial statements. We find that board activity has a positive impact on firm value. Our results also indicate that the external pressure has had a salutary effect and recent regulations have led to some increase in firm value. A second set of proxies is based on the shift to a fully independent Audit, Compensation and Nominating Committees. We find that firms increased the independence of these Board committees following the enactment of the 2002 Sarbanes-Oxley Act.

Implications of financial statement restatements of different items

This study examines short-term market reaction to financial statement restatements conditional on the initial level of noise in a restated account. I find evidence suggesting that the initial degree of estimation of restated items is an important determinant of market reaction. Investors do not penalize firms that restate noisy items as much as firms that make mistakes in precise items. Moreover, investors anticipate restatements of less noisy items, while the restatements of items that involve a substantial degree of estimation come as a surprise.

SEC Comment Letters and Financial Statement Restatements

We use United States Securities and Exchange Commission (SEC) comment letters and accounting restatements to investigate the SEC’s Division of Corporation Finance (DCF) financial reporting oversight procedures. We investigate how DCF compares with “other monitors” in identifying disclosures requiring restatement and how these restatements differ. Our tests focus on DCF as a whole and on the individual industry offices that comprise the DCF. We conclude that, while there are significant variations across DCF offices in the prompting of restatements, company variables used by the SEC to select firms for review appear consistent with SOX section 408 criteria. We also find the oversight process focuses on companies with weaker “other monitors,” i.e. audit firms. Our results provide evidence for the debate on whether or not an SEC type review and comment letter monitoring process could serve as the model for achieving the oversight for IFRS enforcement that is critical to international capital markets.

Financial Restatements and Shareholder Ratifications of the Auditor

SUMMARY: Regulators and legislators have focused significant attention on financial statement restatements in recent years, and the U.S. Securities and Exchange Commission (SEC) and financial statement users view restatements as audit failures. The SEC (2000, 2003a) suggests that shareholder voting on auditor ratification will be impacted by perceptions of audit quality. In this paper we examine shareholder voting on auditor ratifications in 2005 or 2006 following restatement announcements by SEC registrants. We find that shareholders are more likely to vote against auditor ratification after a restatement when compared with votes at (1) firms without restatements or (2) restating firms in the preceding period. Overall, the results provide empirical support to the SEC's assertion that shareholder voting on auditor ratification will be related to perceptions of audit quality, and also support recent actions by shareholder activists to require all firms to submit the selection of the auditor for a ratification vote by shareholders.

Investor perceptions of an auditor’s adverse internal control opinion

In response to recent corporate scandals, Congress passed the Sarbanes–Oxley Act of 2002 (SOX) which, among other things, requires that the auditor render an opinion as to the effectiveness of a company’s system of internal controls. The assumption implicit in this requirement is that the new internal control opinion provides investors with value-relevant information. Our evidence suggests that an adverse audit opinion on internal control over financial reporting provides incremental value-relevant information to investors beyond that contained in the financial statement audit opinion alone. Specifically we find that an adverse audit opinion on internal controls over financial reporting relative to an unqualified opinion is significantly associated with investors assessing a higher risk of financial statement misstatement, higher risk of a future financial statement restatement, higher information asymmetry, lower financial statement transparency, higher risk premium, higher cost of capital, lower sustainability of earnings, and lower earnings predictability. Overall, our empirical results support our hypotheses that the auditor’s opinion on the internal controls over financial reporting provides financial statement users with value-relevant information.

Changes in Market Responses to Financial Statement Restatement Announcements in the Sarbanes-Oxley Era

We examine changes in the market's response to financial statement restatement announcements during the Sarbanes-Oxley (SOX) era. We define this era as beginning with the U.S. Department of Justice initiation of a criminal investigation into the collapse of Enron, and its attendant loss of billions of dollars of shareholder value, through the November 15, 2004, requirement that all U.S. companies with market capitalizations over $75 million must comply with SOX Section 404, which deals with corporate internal controls over financial reporting We divided the Sarbanes-Oxley era into pre- and post-SOX periods, with the dividing line concurrent with the signing of the Sarbanes-Oxley Act into law on July 30, 2002. The comparison of pre- and post-SOX periods shows that post-SOX, the negative impact on companies announcing restatements is reduced 71 percent on average (as measured by the cumulative abnormal return on days 0 and 1) and the positive market response to announced restatements is reduced by 33 percent. This translates into a net reduction in lost market value of $207 million per restatement announcement or $74.4 billion in total market value for the two-day announcement event window. We also find that this reduction is not due to the diluting effects of the increased number of statistically insignificant post-SOX market reactions to restatement announcements. Finally, our results indicate that after SOX became law, post-announcement abnormal returns exhibit statistically significant lower volatility and the trend in statistically insignificant market responses to restatement announcements no longer declines, thus indicating less uncertainty on the part of investors regarding the announcements of restating companies, and perhaps because investors believe the disclosed information conveyed by the restated financials is timelier and of higher quality.