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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Jan 20

Written by: Jack Ciesielski
1/20/2005 12:45 PM 

There's a publicly-traded consulting firm out of Chicago by the name of Huron Consulting Group (ticker HURN) with an interesting heritage: it started life in 2002, founded by a group of mostly ex-Arthur Andersen partners and consultants.

For the last couple of years they've produced an excellent annual study of restatements of financial statements - no shortage irony, there. You can find the 2003 report here. The complete study for 2004 is not yet available, but they've released their summary of findings.And the results are interesting, and they perhaps bear on the current flap over Sarbanes-Oxley.

The report shows that financial restatements (tracked by year filed), rose to 414 in 2004 from 323 in 2003 - a 28% increase. Over 16% of the restatements related to improper revenue recognition; another 16% were related to equity issues: things like stock option accounting and EPS accounting. Over 14% were tied to valuation reserves (for instance, allowance for doubtful accounts, and inventory reserves) along with restructuring and other accruals.

Why the big increase? It may have something to do with the Section 404 internal control reviews, though not directly. We've all been hearing stories of firms crawling with auditors, looking at internal control systems. In their reviews of internal controls, auditors may have become aware that their past understandings of a clients's internal controls were not as good as they thought, and may have uncovered misstatements they should have caught in past years. Or they may be finding errors as they do preliminary year end work in conjunction with their internal control reviews, and insist that their clients restate where possible. Given the higher stakes, auditors may simply be less tolerant of any misstatements than they used to be.

Put simply, the increased auditor activity may have something to do with the restatement increase. Next year, once the pain of dealing with reinvigorated auditors is past, the rush to restate rush might diminish.