Back in the early 2000s, seemingly mild-mannered corporate executives such as Kenneth Lay and Bernie Ebbers came to be known as some of the world’s most notorious supervillains. They weren’t hatching elaborate, cinema-style plots to achieve global domination. Their crimes? Accounting fraud.
Discoveries that companies such as Enron and WorldCom were cooking their books shook the faith of the investing public. A string of corporate accounting scandals eventually sparked the reforms of the Sarbanes-Oxley Act of 2002 calling for greater oversight of public companies and accounting firms. The changes included new rules that were more rigorous about alerting investors to accounting errors and reissuing financial statements.
Practically speaking, “Little r” revisions are less serious and don’t require alerting investors. More significant problems need “Big R” restatements that involve alerting investors and reissuing financial statements.
Over time, the annual numbers of Big R restatements have dropped off precipitously, according to a recent article from The Wall Street Journal. They peaked at nearly 1,000 in 2005. In 2018, the total had fallen to roughly 120.
Seeing as Big R restatements are the kinds of changes that often lead to stock selloffs, it would make sense if that decline resulted from companies developing more vigilant approaches to reviewing and verifying their financial statements. Keep in mind that many executives face the potential for clawbacks in their compensation following Big R restatements, meaning they’re incentivized to enhance their companies’ accounting controls. In fact, the annual total of financial restatements of both varieties declined steadily in the 2005-2018 period, an indication that reporting has grown more precise.
On the other hand, consider some recent revision-related issues that have surfaced in publicly traded companies’ financial statements and correspondence with the Securities and Exchange Commission:
- Papa John’s International determined that some accounting errors affecting its 2016 and 2017 numbers didn’t rise to the Big R level. The pizza chain arrived at the conclusion even though the resulting changes shifted some of its reported numbers by more than 5%, which is considered a threshold for restatements.
- In its Form 10-K for the 2019 fiscal year released Nov. 6, Qualcomm said it identified “an immaterial error related to the recognition of certain royalty revenues of our QTL (Qualcomm Technology Licensing) segment in the quarterly and annual periods in fiscal 2018 and third and fourth quarters and annual period in fiscal 2017.” Again, no Big R restatement.
- REIT Iron Mountain said in a quarterly report issued in October that the company created a reserve fund to address a newly discovered value-added tax liability in the Netherlands. Although the move prompted revisions to past consolidated financial statements, Iron Mountain classified them as immaterial.
Less charitable observers might argue that the system as it currently stands encourages companies (and executives with compensation on the line) to bump more serious problems down to lesser issues of the Little r variety. The WSJ article pointed out that one study found the SEC questioned 116 of the more than 2,700 accounting errors between 2009 and 2015 that didn’t get the Big R treatment. Only one eventually led to a Big R restatement.