Restatement: Screw-up or True-up?

The PCAOB says auditor reports should distinguish between restatements caused by errors and those made simply because a company adopted a new accounting principle.

A proposed auditing standard could help companies more clearly show that a restatement occurred because they implemented a new accounting rule or changed their accounting methods — and not because they had made an accounting error.

Since the Financial Accounting Standards Board adopted FAS 154, Accounting Changes and Error Corrections, companies have been required to restate their current and previous financial reports when they decide to use a different accounting method or comply with a rule change. In mid-2005, FASB decided that applying changes retrospectively made sense and the board wanted to match up this rule with a similar International Accounting Standards Board standard. It eliminated the practice of recording a one-time cumulative effect in the income statement in the year the new accounting principle is adopted.

As a result, however, auditors’ reports highlighted that a company had restated its financial reports — which left uninformed investors, unclear why the adjustment had been made, with a negative taste in their mouths. “The new accounting likely added confusion as they may be unable to tell whether the restatement resulted from a change to a more preferable — or new — accounting standard, or was due to the correction of an error,” Denise Dickins, assistant professor of accounting and auditing at East Carolina University, told CFO.com.

Earlier this week, the Public Company Accounting Oversight Board offered a fix to this investor misunderstanding. Put another way, the new standard could give investors a better idea of when the change was the result of a mistake. “It would be a clear alert that a misstatement had occurred,” said Keith Wilson, PCAOB associate chief auditor. The board released its proposed standard, Evaluating Consistency of Financial Statement, for public comment for 45 days.

Considered one of the PCAOB’s priorities for 2007 (though less so than the ongoing push to adopt a new internal-control auditing standard), the proposal is a response to FAS 154.

In tandem with this new auditing standard, the PCAOB is also proposing to remove the hierarchy of generally accepted accounting principles in its interim standards. FASB intends to incorporate the GAAP hierarchy — the authority of accounting rules and opinions issued by the differing accounting organizations over the years — into its accounting standards. All of PCAOB’s standards are subject to the approval of its overseer, the Securities and Exchange Commission.

A new auditing standard wasn’t the only order of business at this week’s PCAOB meeting. The board members also approved of the staff’s recommendation to ask for feedback on an aspect of a rule that addresses audit firms’ independence and CFOs’ personal tax needs.

Last November, accounting firms registered with the PCAOB started to comply with Rule 3523, Tax Services for Persons in Financial Reporting Oversight Rules. The rule disallows external auditors to provide tax services during the audit and professional engagement period to CFOs, their counterparts, and their family members. The gist of the PCAOB’s question concerns timing: can the firm that has helped an executive with his or her taxes be allowed to accept an assignment as the company’s auditor later in the same year (assuming the firm would stop providing tax work for the executive)? The PCAOB is soliciting public comment for 45 days.

The staff also released a list of questions and answers for following Rule 3523, which is still in effect.

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