Following three-plus years of painful adjustments brought about by Sarbanes-Oxley, companies may be finally getting a handle on how to use SOX to their advantage. For the first time in a decade, according to a Glass Lewis & Co. report, there has been a year-over-year decline in the number of restatements filed by public companies. During 2007, companies filed 1,289 financial restatements, down 15% from 2006, when restatements peaked at 1,524. Among companies with at least $75 million in market capitalization, restatements were down 5% to 560.
Restatements spiked in the early years of SOX, partly because SOX forced companies and auditors to re-evaluate accounting policies. "The re-evaluation of risk that occurred during that time necessarily resulted in [more] restatements," says PCAOB board member Charles Niemeier. "Internal controls played a part in that, as a vehicle for risk re-evaluation. As material weaknesses decrease and companies complete SOX 404 implementations, it should lead to fewer restatements."
Despite four years of 404 audits by larger companies, SOX implementations are still far from complete at smaller cap companies, he notes. As a result, "we may see more restatements as implementations take place there," he says.
However, some question whether the surge in restatements and subsequent decline are evidence of real improvement. For instance, Heriot Prentice, director of professional practices at the Institute of Internal Auditors, does not believe the surge was necessary. "The decline in restatements is primarily due to consideration being given to whether a prior period error is really material, and whether a restatement is required," he contends.
A flurry of new accounting rules, which confused auditors, companies and even sometimes the Financial Accounting Standards Board (FASB), also contributed substantially to the restatements spike. One notable troublemaker: FAS 133, which dictated accounting for hedges, caused restatements by such major companies as General Electric Co. and Fannie Mae. Uncertainty over the revised FAS123, which requires the expensing of all stock options, also led to a wave of restatements in 2005; previously, companies only had to expense options that were in the money. "When the revised FAS123 came out," says Brian Hogan, a doctoral candidate in accounting at Case Western Reserve University, "companies began scrambling to understand how options should be measured and restated accordingly."
Besides fewer restatements, other encouraging signs include more financial reports being filed on time and companies changing external auditors less often.