Department

Accounting

Publication Year

Spring 2015

Abstract

The current Securities and Exchange Commission authoritative guidance on proper accounting treatment of prior period immaterial errors is accused of allowing certain financial statement abuses. Current SEC regulations and guidelines that allow for financial restatements are designed to provide more accurate financial statements, transparency when misstatements or errors are corrected, and therefore to increase the information content of earnings, but this goal is not always accomplished. Investors and users of the financial information have expressed concerns that the guidance is being misused for earnings management.

The findings of this study rely predominantly on data, trends, and activity spanning the periods of 2003-2014. This time period includes key events which occurred in the past decade such as the implementation of the Sarbanes Oxley Act (SOX) of 2002, the SEC’s 2004 introduction of non-reliance reporting on Form 8-K Item 4.02, the SEC’s 1999 issuance of Staff Accounting Bulletin (SAB) 99 on determining materiality, and SAB 108 on quantifying discovered prior errors, issued in 2006.

This paper examines and clarifies the current guidance on correcting immaterial errors, as well as provides the reader with information to conclude whether the status quo is viable. There are several policy changes that regulatory bodies could implement to increase the effectiveness of the current authoritative literature, as well as improve the level of clarity when dealing with the somewhat complex process of correcting misstatements. Proposed policy changes include changes to financial statement labeling, the content included in the footnotes, in press releases, certain performance metrics, as well as stricter enforcement of the requirements. With added disclosure, users will be made aware that the correction has occurred, and be in a better position to evaluate its impact on an ongoing basis.

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