The decision is usually made in a single meeting. The audit committee concludes that previously issued financial statements should no longer be relied upon, the filing goes out, and the announcement is over in an afternoon. What follows is one or two quarters in which the finance and operations teams do two periods of work at once, on dates set by regulation, not by the team's capacity. Over the trailing twelve months, SEC full-text search returns 139 filings reporting non-reliance on previously issued financial statements. Each one started the period described here, and in a company under roughly a thousand employees it falls on a team with no spare capacity and no internal software group.
What The Filing Starts
The non-reliance filing sets dates that, unlike a project date, are not negotiable.
- Amended filings. The affected periods have to be restated and re-filed, which means re-performing the affected closes rather than adjusting a summary.
- A late filing, in most cases. Rule 12b-25 grants an extension — five calendar days for a quarterly report, fifteen for an annual one. That extension is the calendar's only slack.
- The current period, still due. Nothing about the restatement moves the date of the next close. Both of them run in parallel, and they run with the same staff.
- An auditor with a changed posture. Under the standard governing audits of internal control over financial reporting (PCAOB, AS 2201), the restatement of previously issued financial statements to correct a material misstatement is listed as an indicator of a material weakness. Testing widens just when the team has least room.
The restatement does not add a project to the quarter. It adds a second quarter to the quarter, and the second one is being watched.
The Error Was Almost Never Exotic
An analysis of the underlying causes attributed to restatements (Plumlee & Yohn, Accounting Horizons, 2010) found that companies most often attribute restatements to a basic internal company error unrelated to any characteristic of the accounting standards.
The distinction matters for what you do next. The importance of distinguishing errors from irregularities (Hennes, Leone & Miller, The Accounting Review, 2008) separates intentional misstatements from unintentional ones and shows how far apart the consequences sit: an average market reaction of about negative 14% for the irregularity group against about negative 2% for the error group. Most restatements are of the unintentional kind, and the unintentional kind has a recognizable operational cause. A basic internal error, in a company this size, has a recognizable shape. A value was carried from one place to another by a person. A version of a file was superseded and the earlier one was used. A step that should have run first ran second. A reconciliation was performed correctly and against the wrong extract. These are handoff failures in a process with no way to enforce its own order.
The Correction Runs On The Process That Failed
The restatement is corrected using the same process that produced the error, operated by the same people, under more time pressure and more scrutiny than before.
That process is usually a chain of spreadsheets, extracts and emails around the ERP, which covers the reporting path, not the work at the edges of it. Re-performing a prior period means reconstructing the inputs used at the time, which the process did not retain.
Three things then consume the quarter:
- Reconstruction. Finding what the reported numbers were originally built from, when the source has since changed and no earlier version of it was kept.
- Re-performance. Redoing the affected closes in order, during the current close.
- Evidence production. Proving that each step ran, in order, by the right person — a separate task from the work, and a task the process was never designed to produce.
Adding people helps the second of these and makes the first and third worse, because a larger team creates more handoffs in a process where the handoff is the failure point.
The Change That Reduces Work Instead Of Adding It
Most items on a post-restatement remediation plan add work: another review, another reconciliation, another sign-off. Each consumes capacity in a quarter that has none to spare. One class of change does the opposite. Change the step so that performing it produces its own record, in order, and it cannot complete out of order. The item cannot advance until it carries a stamped approval. The reconciliation opens a versioned extract recorded against the result. The exception sits in a queue with an owner and a due date.
| Usual remediation item | Cost each period | The alternative |
|---|---|---|
| An additional reviewer | Recurring hours, forever | Held until approval is recorded |
| A new checklist | Hours, plus document upkeep | The system enforces the order |
| Quarterly management certification | A scramble at each close | An existing list, exported |
| More frequent reconciliation | Multiplies the original work | Versioned inputs make it cheap |
The right-hand column is software, and it is a small amount of it. This is the same conclusion that the material weakness disclosure arrives at from the opposite direction.
First Steps
- List the steps in the affected process done by hand, in order. Beside each, write what record shows it was performed. Steps with no record are where the error came from.
- Pick one step whose inputs cannot be reconstructed. Versioning one step's input removes most of the reconstruction cost for that step permanently.
- Separate the remediation items that add recurring work from those that remove it. Present both lists to the audit committee. The second is short and survives next year.
Do The Two Quarters Once
The period after a non-reliance filing is the worst time to start a long software project and the best time to fix one step, because the current process's cost is visible to everyone.
A fifteen-minute call — nothing paid, nothing signed — takes one step of the affected process apart: what record it must produce, where the inputs come from, what has to be built, and what it costs. If your systems hold what is needed and the work is retention and reporting, that is what we will say, a result worth having before the auditor asks.
Where something must be built, that work runs as a monthly engineering partnership, against measures written before each release. Paid-for deliverables transfer to you monthly, with full history and documentation. Then $10,000 a month keeps one accountable person on the system and produces a written monthly record of what ran and changed.
References
- U.S. Securities and Exchange Commission. Form 8-K. Item 4.02 covers non-reliance on previously issued financial statements.
- U.S. Securities and Exchange Commission. Form 12b-25, Notification of Late Filing.
- Public Company Accounting Oversight Board. AS 2201: An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements. PCAOB Auditing Standards.
- Plumlee, M., & Yohn, T. L. An Analysis of the Underlying Causes Attributed to Restatements. Accounting Horizons, 2010.
- Hennes, K. M., Leone, A. J., & Miller, B. P. The Importance of Distinguishing Errors from Irregularities in Restatement Research. The Accounting Review, 2008.
