Q. When does a company need to restate its financial results?
Ans. Restatements in financial statements are made for many reasons.
Generally, firms restate financial statements when;
Q. How far back can it restate?
- A change in accounting principle. (A change from straight-line to
declining- balance depreciation)
- A change in accounting estimate. (A change in the estimated useful
life or estimated residual value of depreciable asset.)
- A change in reporting entity. (Substitution of consolidated statements
for individual company financial statements)
- Error correction.
Ans. There are three approaches
in restatement of financial statements.
Q. How would restating affect the company stock price?
- Current approach: This method recognizes in current period earnings
the cumulative difference between the total expense or revenue under
the old and new accounting principles for all affected prior periods
up to the beginning of the current period. (Companies post this amount,
if any, to the account titled Cumulative Effect of Change in Accounting
- Retroactive Approach: This method restates all prior financial statements
presented on a comparative basis to conform to the new principle.
- Prospective Approach: This method applies revised accounting estimates
to current and future periods affected by change. Prior financial statements
remain unchanged, and no cumulative effect effect on prior years' income
restatements in financial statements affect stock prices. The goal of
financial reporting is to provide useful and comparable data to third
parties. (Investors, government,...) Third parties justify the usefulness
of any relevant financial data by making time series analysis and cross-sectional
analysis. Any changes in past financial data will affect the current perception
of investor, because:
If restatements are material, then inevitably there would be big changes
in time series analysis, which means new information about riskiness of
the company. Consider the following excerpt from USA Today of 3/20/2000:
- The sustainability, measurement, or manageability of the reported
(un-restated) earnings number keep it from reflecting economic value-added
of a firm.
- Financial statements of previous years are restated in the current
- Financial statement items are classified in different ways across
MicroStrategy tanks on restatement news
VIENNA, Va. (Bloomberg) - MicroStrategy Inc., an inventory-management
software maker, said it is revising revenue and operating results for
the past two years because of a change in the way it accounts for software
sales. The shares tumbled 62%.
In the case of MicroStrategy, restatements in the past years' earnings
affected the current price of the company. Whatever the current
year (2000) earning of MicroStrategy before restatement of financial statements,
since the trend of earning has changed significantly after restatement
and the market has perceived it as a bad sign for MicroStrategy's future.
Q. What causes a company to restate its earning?
A. These changes sometimes are required by regulating authorities or
companies make them voluntarily.
The reasons are:
-To improve matching of expenses and revenues
-To enhance asset valuation
-To provide new information
-To respond to changed economic/market condition
-To comply with new reporting standards
In addition to restatement of financial statements, an investment student
should always keep in mind that using financial statements as given by
companies may cause misleading judgments about future performance of companies.
Disclosures in some accounts of financial statements are prime candidates
for judging the company's future.
2-Extraordinary gains and loses
3-Changes in accounting principle
6-Changes in estimates
7-Gains and losses from peripheral operations.
Before making any analysis (ratio, trend,...) these accounts should be
- Intermediate Accounting, Dyckman/Dukes/Davis, 4th. Edition, Irwin/McGraw-Hill,
- Financial Reporting and Statement Analysis, Stickney/Brown, 4th.
Edition, Dryden, pp.202,203,204,205,210,211,229
- Financial Statement Analysis, Bernstein/Wild, 6th. Edition, Irwin/McGraw-Hill,
- Investment Analysis and Portfolio Management, Reilly, 3rd. Edition,