​​Financial Restatements: The Impact to Newly Public Companies

Navigating the Transition: Understanding Challenges Faced by Newly Public Companies and Strategies for Success

In the dynamic landscape of public offerings, the surge in initial public offerings (IPOs) during 2020 and 2021 led to a record number of companies going public through traditional IPOs or SPAC mergers. However, the parallel rise in IPOs and accounting restatements offers a significant insight into the challenges new public companies face. These companies, while transitioning to public status, are often still fine-tuning their internal controls, accounting policies, team structure, and technology integration. This leaves them susceptible to internal control weaknesses, restatements, and the need for remediations.

What Is a Restatement?

A restatement is the rectification of previously released financial statements, prompted by errors or misinterpretations. This commonly happens during the transition of newly public firms. Such revisions entail correcting mistakes, including significant inaccuracies, stemming from sources like accounting errors, noncompliance with GAAP, fraud, or clerical blunders. Accountants assess materiality, and if flawed data could result in misleading interpretations, restatements become obligatory under FASB rules. 

A Deeper Dive into Restatements

A survey conducted in 2022 by Deloitte highlighted that approximately 59.1% of public companies revised or remediated their financial processes within the past 12 months, with 51.6% anticipating the same within the next year. Delving deeper into newly public companies that encountered restatements, Deloitte’s discussions with CFOs revealed three recurring themes contributing to these events:

• Complex Accounting Standards: The transition to newly applicable accounting standards often requires more judgment and estimates. These intricate standards can challenge companies, leading to restatements.
• Manual Processes and Controls: The process of refining internal controls, often through manual processes and multiple spreadsheets, can create an environment prone to errors.
• Lack of Specialized Skills: New public companies might lack staff with deep technical expertise in these evolving standards, increasing the likelihood of misinterpretations and errors.

Areas of Common Restatements

Based on Securities and Exchange Commission (SEC) filings, one of the most common areas for restatements in newly public companies since is leases (ASC 842). The nuances and complexities within ASC 842 often require technical accounting expertise and pose challenges for newly public entities.

Responding to Restatements

Responding to restatements requires a methodical approach:

1. Create a Plan: Establish a project management office (PMO) with clear protocols, resources, and communication channels to address the issue.
2. Assess Resources: Enlist resources with deep technical knowledge to address the complexities causing restatements.
3. Evaluate Misstatements: Investigate the cause of the misstatement and adjust financials accordingly.
4. Identify Control Failures: Understand the root cause of internal control deficiencies and prepare a remediation plan.
5. Communication: Keep stakeholders informed, including auditors, board of directors, investors, regulators, and banks.
6. Complete Reporting: Prepare restated financials and disclosures to explain the misstatement’s cause and impact.
7. Repair and Improve: Use the lessons learned to enhance controls and processes, minimizing the risk of future restatements.

Preventing Future Restatements

Preventing future restatements involves building a resilient accounting organization:

• Continuous Controls Assessment: Regularly assess internal controls to adapt to changing business conditions and technology.
• Stay Current: Monitor regulatory changes that might affect accounting and financial reporting.
• Leverage External Advisers: Engage accounting and reporting advisers with specialized skills to analyze complex issues and offer solutions.

With the intricate landscape of accounting standards and the unique challenges that newly public companies face, establishing a knowledgeable team, strong controls framework, and proactive remediation strategy can significantly reduce the risk of restatements and ensure a smooth transition into the public market.