July 21, 2014
In 2013, 234 public companies filed a form 8-K, item 4.02, announcing a restatement of financials. This is the second post in our series surveying those financial restatements. This installment will focus on the types of errors that led to restatement. For further information on this series, please see the first post.
Under Generally Accepted Accounting Principles (GAAP), most errors in previously issued financial statements are corrected via an amendment called a “restatement.” Restatement is a dreaded word in corporate accounting circles. One commentator likened a restatement to a “death in the family.” Section 250 of the Financial Accounting Standards Board’s Accounting Standards Codification gives an inkling of the array of errors that might blight a financial statement, including math mistakes, incorrect application of GAAP, oversights, misuse of facts, fraud, and use of non-GAAP accounting standards. 2013’s restatements saw virtually every one of these error types.
Nearly half of 2013’s restatements remedied a prior statement’s incorrect application of a GAAP principle. We classified these as “accounting principle” errors. Among these, the most common mistake was treating warrants to purchase equity, as Global Eagle Entertainment did, as “components of equity instead of as derivative liabilities” (8-K, Global Eagle Entertainment Inc., February 26, 2013). Other examples of misapplied GAAP principles include more complex situations like Insulet Corp’s reporting of a “reduction of its preexisting valuation allowance” as “an income tax benefit and not as an adjustment to goodwill” (8-K, INSULET CORP, February 08, 2013). Far less common were cases where the issuer employed the wrong GAAP principle. Examples include URS Corp, which had to restate after it “incorrectly calculated the fair values” of financial instruments “according to previous rules”(8-K, URS CORP, November 05, 2013), and E Waste Systems, which corrected reporting for a business unit to treatment as “a leased operation instead of a consolidated entity” (8-K, E WASTE SYSTEMS INC, November 19, 2013).
The second-most common error involved financial statements containing incorrect information due to oversight or mistake. We identified these errors as “clerical.” Examples include RTI International Metals, forced to file a second 4.02 8-K immediately following a restatement because it discovered “a computational error had been made in calculating the effect of the original corrections discussed above” (8-K, RTI INTERNATIONAL METALS INC, October 28, 2013), and MolyCorp, which announced a restatement after discovering an “error with respect to the reconciliation of its physical inventory to the general ledger, which resulted in a cumulative overstatement of costs of sales and understatement of current inventory” (8-K, MOLYCORP INC, August 08, 2013).
When important information was simply left out of a prior financial statement we described the error as one of “omission.” Examples include Fab Universal, which announced a restatement after discovering a subsidiary had “entered into a $16.3 million bond offering in China which was not reflected on the 2013 Interim Financial Statements” (8-K, FAB UNIVERSAL CORP, December 10, 2013) and North Bay Resources which “discovered it had inadvertently issued and sold unregistered securities” (8-K, NORTH BAY RESOURCES INC, July 17, 2013).
When the 8-K described errors resulting from intentional bad conduct we classified the error as “misconduct.” Examples include Active Power, which announced restatement after “management … discovered [a] Company employee in China intentionally misrepresented the relationship between Qiyuan and Digital China” (8-K, ACTIVE POWER INC, November 07, 2013), and Maxwell Technologies, which discovered that contracts written by one employee did not have a “fixed or determinable sales price … nor was collection reasonably assured” (8-K, MAXWELL TECHNOLOGIES INC, March 07, 2013).
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