How To Do A Financial Restatement
Financial Restatement means that there are errors in a company's financial statements that need to be corrected. Ultimately, it is a revision of previously issued financial statements to correct the misstatements that are material in amount.
Why do Financial Restatements happen in the first place? Most of the time, it is due to negligence on the Company's part by not taking their accounting seriously. Other times, it may be fraud that was perpetrated and a cause for a full restatement. This has happened many times in the arena of publicly traded companies.
For this article, my focus is to help the small to mid-sized companies that have this problem, restate their financials correctly and develop the accounting processes and fraud detection to ensure that this never happens again.
Financial Restatement Process
This overview is to give you an idea on how to do a Financial Restatement, but please understand that it is much more complicated than the process may lead you to believe. The main reason is that Forensic Accounting techniques usually need to be employed. Forensic Accounting is an investigative process to rule out fraud, but is also used to substantiate the accounting that had occurred in the past. If the accounting was never done correctly in the first place, the accounting records need to be built from scratch most times, using what was found through the investigation.
The Balance Sheet is the first place to start as each account needs to be substantiated by documentation first. This will come into play later, but note that the offsets to all of the entries on the Balance Sheet, will eventually flow to the Income Statement. That is why the two sided nature of accounting exists! It's all one big puzzle.
Cash is king and is the ultimate truth teller in accounting. Therefore a Financial Restatement starts with the reconciliation of all cash accounts. Again, depending upon how bad the financials were kept, a complete rebuild may need to be done.
Once Cash is reconciled, the Restatement Accountant should be going through each Balance Sheet account and establishing the credibility of the balances using 3rd party backup.
For example, if the business uses accrual accounting, the Accountant should be accounting for Revenue that needs to be recognized in the current year, but was paid in the next. If the current year Accounts Receivable account was $0 at the end of the current year, but there was cash that came in at the beginning of the next year from receivables, the Accountant needs to work backwards to rebuild what the Accounts Receivable balance should have been at year end.
This Financial Restatement process follows all the way down the Balance Sheet. If there are any balances that are unable to be substantiated, they need to be taken to a write off account. Believe me, there have been many times where I have had to clear Balance Sheet accounts because the accounting was so horrific, that to reconcile the balance all the way back to the beginning, would be too costly for the business. Again, the key is to develop accounting processes that will ensure restatement doesn't happen again, so as the Accountant is going through the Balance Sheet, he or she should be formulating revamped steps to build the future accounting department.
The Income Statement or Profit and Loss (P&L) is always tackled after the Balance Sheet has been restated. Because the Cash and Credit Card accounts have been reconciled, we know that those transactions happened and, because accounting is a two sided entry, if Cash is correct, then the job is to make sure the other side of the entry is correctly accounted for. Since we know that our Balance Sheet is correct, we can assume that all other entries will be hitting the P&L.
Think about it, if our Cash and Accounts Receivable balances are correct, then our Revenue account should be correct. Obviously, we need to look at the detail and rebuild Revenue to the subsystem if needed, but in general, this is how our Revenue account becomes accurate.
Finally, every account on the Income Statement is reviewed in detail to check off that the expenses are categorized correctly.
Once the Balance Sheet is fully substantiated and all Profit and Loss accounts are reviewed, the Financial Statements are restated.
Again, this is a simple format to a difficult process and should not be undertaken by non-accountants or bookkeepers. You don't want to end up in the same spot you are trying to get out of.
The end result of all this work are financial statements that the business can make informed decisions from and accurately file its taxes.
If you have any questions or need help with your Company's Financial Restatement, contact us and we can discuss the potential solutions.
Blue Collar CFO