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Taub Reveals Results of Staff Review of Restatements

In remarks last month to Financial Executives International, Deputy Chief Accountant Scott Taub reported the results of an internal staff review on the causes of financial reporting restatements. Taub was the acting director of the SEC's Office of the Chief Accountant when he presented his remarks in New York. Conrad Hewitt was subsequently named chief accountant and Taub has since announced his plan to leave the Commission. Based on the staff's review, over half of the errors that led to restatements were caused by ordinary books and records deficiencies or by the misapplication of accounting standards. Taub's prepared remarks were posted on the SEC's Web site.

The staff reviewed information about restatements in filings from 2003 to 2005. The staff considered whether the disclosures about restatements suggested that the U.S. financial reporting environment contributed to the error, or whether it was caused by a deliberate misstatement or a misapplication of an accounting standard.

About one-third of the errors that were reported were caused by factors outside of the company, according to Taub. In 15% of the restatements, judgments in applying an accounting standard were a contributing factor. These restatements most often related to inventory, reserves and allowances, taxes, impairments of long-lived assets and intangible assets.

Taub said that some people would conclude that accountants and auditors should spend more time with respect to their accounting judgments, while others may conclude that regulators are second-guessing companies too often. A move to more principles-based standards will require a greater reliance on the judgments of accountants, he said, so this issue may require further consideration.

The accounting literature appeared to contribute to about 15% of the restatements, particularly in transactions involving convertible securities with beneficial conversion features and equity instruments issued to third parties. Taub said a lack of clarity in the standards may have contributed to these errors, but there were also problems in identifying all of the relevant accounting literature and with the complexity of the literature.

The staff looked at the accounting areas in which most of the errors occurred and where the standards were most often misapplied. Taub said the number of errors did not necessarily suggest that the accounting literature is poor, but that it merits further consideration. The areas that presented the most problems included leases, income taxes, revenue recognition, derivatives and hedging, and convertible securities, according to Taub. He noted that all of these areas are projects on FASB's agenda.

The staff also tried to determine how the companies discovered the errors. Taub said that information about the source of the error was not available in many cases. He believes that market participants would want to know this information and pondered whether something should be done to encourage the disclosure. In some cases, companies would disclose the discovery of an error but with little discussion about how it occurred. Of the companies that disclosed how an error was found, about 15% said the external audit was the source of the discovery. Staff reviews accounted for about 10% of the discoveries. In the 2005 audits, about 5% of the restatements were as a result of a section 404 internal control review.

While the analysis was informal and based on the staff's interpretations of the disclosure, Taub said it provides material for further consideration.

Jacquelyn Lumb