The decision is usually made in one 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 not an afternoon. It is one or two quarters in which the finance and operations teams do two periods of work at once, on dates that are set by regulation rather than by capacity.
Over the trailing twelve months, SEC full-text search returns 139 filings reporting non-reliance on previously issued financial statements. Those are filings rather than companies. Every one of them started the same period we are describing, and in a company under roughly a thousand employees it is started by a team that has no spare capacity and no internal group that builds software.
This article is about that period: what it actually consists of, why the existing process cannot absorb it, and the one kind of change that reduces the work instead of adding to it.
What The Filing Starts
The non-reliance filing is the beginning of a sequence with fixed dates in it, and the dates are not negotiable in the way an internal project date is.
- 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 allows a notification of late filing and grants a short extension — five calendar days for a quarterly report, fifteen for an annual one. That is the entire slack the calendar contains.
- The current period, still due. Nothing about the restatement moves the next close. Both run in parallel, 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. The scope of testing widens at exactly the moment 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
Executives outside finance often assume that a restatement implies either aggressive accounting or an unusually difficult standard. The evidence does not support that assumption. An analysis of the underlying causes attributed to restatements (Plumlee & Yohn, Accounting Horizons, 2010) read what restating companies themselves said, and found that companies most often attribute a restatement to a basic internal company error unrelated to any particular 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, with fraud-related class actions almost entirely confined to the first. Market reactions to restatement announcements (Palmrose, Richardson & Scholz, Journal of Accounting and Economics, 2004) are negative on average, and more negative where the restatement involves fraud or affects more accounts. The distinction is worth holding on to during a difficult quarter: most restatements are 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 before another one ran after it. A reconciliation was performed correctly and against the wrong extract. None of those are accounting failures in the technical sense. They are handoff failures in a process that has no mechanism to enforce its own order.
The Correction Runs On The Process That Failed
Here is the part that makes the period so expensive, and it is rarely stated plainly in the remediation plan. 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 enterprise system, which covers the standard reporting path and not the work at the edges of it. When the team re-performs a prior period, they cannot simply re-run it. They have to reconstruct which inputs were used at the time, which is exactly the information the process did not retain.
Three things then consume the quarter:
- Reconstruction. Finding what the numbers were built from, when the source has since changed and no version was kept.
- Re-performance. Doing the affected closes again, in order, while the current close is also running.
- Evidence production. Assembling proof that each step happened, in order, by the right person — which is a different task from doing 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 is defensible in isolation and each consumes capacity in a quarter that has none. There is one class of change that does the opposite, and it is worth identifying before the plan is finalized.
Change the step so that performing it produces its own record, in order, and cannot complete out of order. The reviewer does not send an email; the item cannot advance until it carries a stamped approval. The reconciliation does not open a fresh extract; it opens a versioned one that is recorded against the result. The exception is not carried in someone's head until Friday; it sits in a queue with an owner and a date.
| The usual remediation item | What it costs each period | The alternative |
|---|---|---|
| An additional reviewer | Recurring hours, forever | The step will not complete without a recorded approval |
| A new checklist | Hours, plus a document to maintain | The order is enforced by the system, not by the checklist |
| A quarterly management certification | A scramble at each close | A list that already exists and can be exported |
| More frequent reconciliation | Multiplies the original work | The inputs are versioned, so the reconciliation is cheap |
The right-hand column is software, and it is a small amount of it. This is the same conclusion the material weakness disclosure arrives at from the other direction, and it is the reason the two filings so often appear within a year of each other.
First Steps
- List the steps in the affected process that a person performs by hand, in order. Beside each, write what record exists today that it was performed and when. The steps with no record are where the error came from and where the next one will come from.
- Pick the one step whose inputs cannot be reconstructed. Reconstruction is the largest single cost in the quarter, and versioning the input to one step removes most of it for that step permanently.
- Separate the remediation items that add recurring work from the ones that remove it. Present both lists to the audit committee. The second list is short, and it is the one that survives next year.
Do The Two Quarters Once
The period after a non-reliance filing is the worst possible time to start a long software project and the best possible time to fix one step, because the cost of the current process is visible to everyone in the company for the only time in its life.
A fifteen-minute call — nothing paid, nothing signed — takes one step from 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 existing systems already hold what is needed and the work is retention and reporting, that is what we will say, and it is a result worth having before the auditor asks.
Where something has to be built, that work runs as a monthly engineering partnership, against measures written down before each release starts. The work runs in a repository we own, and paid-for deliverables transfer to you monthly — full history and documentation. After that, $15,000 a month puts one accountable person on keeping it running and produces a written monthly record of what ran and what changed — the kind of artifact an audit committee reads with relief rather than with questions.
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.
- Palmrose, Z.-V., Richardson, V. J., & Scholz, S. Determinants of Market Reactions to Restatement Announcements. Journal of Accounting and Economics, 2004.
- U.S. Securities and Exchange Commission. EDGAR Full-Text Search. Filing counts cited are from full-text search over the trailing twelve months.
