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Restating Financial Statements: Purpose, Rules & Process

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  • 0:03 Restating Financial Statements
  • 1:15 Materiality
  • 1:44 Accounting Errors
  • 3:56 Fraud and Misrepresentation
  • 5:00 Changes in Accounting…
  • 5:29 Lesson Summary
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Lesson Transcript
Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

A restatement is the revision and publication of one or more of a company's previously issued financial statements. We will cover when restatements are required and go through some examples.

Restating Financial Statements

A restatement is the revision and publication of one or more of a company's previously issued financial statements. The purpose is to advise statement users of erroneous information in previously released statements and provide corrected documents. Statement users often make important investment decisions based all or in part from financial statement data. Correcting them is not only important but required in generally accepted accounting principles (also referred to as GAAP) for three types of errors:

  1. Accounting errors- These are almost inevitable when large volumes of information and transactions are entered into accounting systems. But not all errors will require restatement!
  2. Noncompliance with generally accepted accounting principles (GAAP) - This can be done deliberately or just arise from not knowing applicable GAAP procedures.
  3. Fraud and misrepresentation - This arises when financials with inaccurate information are issued with the intent of deceiving users of the financial statements.

The materiality test is then applied to determine if the amount requires restatement.

Materiality

To be considered material, the amount in question would lead those receiving the financial statements to come to an inaccurate conclusion as part of a standard analysis of the financials. Let's say an analyst is reviewing the financials of a company as part of a recommendation to his clients to buy the stock. A material amount would be large enough to influence his buy or don't buy recommendation when doing a standard analysis. Accounting rules require restatements only for items that are material.

Accounting Errors

Fast Food Truck Company caters to the lunch crowd in a major US city where people like to eat their lunch outside. Business has been booming lately! The senior accountant is a CPA. She conducts periodic audits of the accounting entries for accuracy and compliance with GAAP. She has uncovered two items of concern.

  1. A staff accountant incorrectly calculated straight line depreciation on some cooking equipment. The amount is $100 and it only affects the current year.
  2. Another accountant incorrectly booked the purchase of a new food truck last year. Instead of booking the truck as an asset and the bank loan as a liability, he entered the $30,000 purchase as 'food truck expense' into the accounting system.

She sets up a meeting with the owner to go over the audit results.

''I'm not surprised you found these errors,'' he tells the CPA. ''We have been so busy lately I'm afraid the accountants have been getting a little too much data to input!'' He is concerned about both of them. ''That miscalculation puts us out of line with GAAP, what do the rules say about that?'' The CPA advised that it still isn't a problem because $100 isn't considered material. ''We are still a healthy growing business with or without that $100,'' she says. ''We only need to fix it in our current year's books, and since they haven't been published yet we don't need to restate anything.''

''The other one is a big problem though,'' the CPA said. ''$30,000 is certainly big enough to make a difference, so it is material. Last year's financials are going to look quite different when we restate them. Look at all of the income statement items that are affected.''

Income Statement Item Error
Expenses $30,000 too high
Pre-tax income $30,000 too low
Taxes @ 33% $10,000 too low
Net Income $20,000 too low

''And on top of those errors, a depreciation account will need to be set up for the truck with depreciation expense taken starting this year,'' explained the CPA.

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