To Err Is Human, and Common

Yes, accounting standards are complex, but simple mistakes are what cause most financial restatements.

The Sarbox era has seen a surge in both financial restatements and the finger-pointing associated with them. The two most commonly blamed villains are confusing regulations and overly conservative auditors, but new research challenges that conventional wisdom.

Marlene Plumlee, of the University of Utah, and Teri Lombardi Yohn, at Indiana University, looked at 3,744 restatements from 2003 to 2006 and found that, across companies of all sizes, simple human error on the part of internal staff is to blame 56 percent of the time. Not that vexing accounting standards are a nonissue: they finish a strong second, responsible for 38 percent of restatements. Of those, the problems typically lay either in a lack of clarity in the standard itself (58 percent) or in the use of judgment (or misjudgment) in applying the standard (37 percent).

“I was pretty disappointed in the quality of accounting,” says Plumlee. “It suggests that companies need to do a better job of implementing internal controls, and make sure the people that they have working for them are well trained.”

While error-ridden financial statements are bound to displease accounting professors, there is a bright spot: the material effect of restatements is diminishing. The study revealed that, over the years, the proportion of restatements with a net income effect of more than 5 percent of total assets has decreased by 7 percent.

Plumlee and Yohn say that regulators should take note of these findings. “FASB, the SEC, and the PCAOB are all trying to create initiatives to curb restatements and make changes to the system,” says Plumlee. “We thought it would be useful to know what the underlying causes actually are.”

Causes of restatements

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