Revenue Recognition Restatements Increase 42% as Basic Accounting Errors Plague Reporting

Revenue recognition restatements increased 42% from 2002 to 2006 leading to a lot of speculation about the underlying causes. With all the hype about Sarbanes-Oxley, increased auditor scrutiny, and complex guidelines it is surprising to learn that mundane internal errors were the leading cause of restatements from 2003 to 2006. That’s the conclusion of a new report entitled “An Analysis of the Underlying Causes of Restatements” by Marlene Plumlee, University of Utah and Teri Lombardi Yohn from Indiana University.

The authors analyzed 3,744 disclosures related to each restatement to identify and categorize the underlying causes. Of restatements caused by revenue recognition errors, approximately: 57% were due to a basic internal error, 28% were due to some characteristic of the accounting standards, 13% were due to intentional manipulation, and 2% were due to transaction complexity. That would make over half of all revenue recognition restatements avoidable if companies had better procedures for performing, monitoring, and controlling their revenue processes.

Figure 1
Leading Causes of Revenue Restatements 2003 - 2006

For restatements that were caused by accounting standards, “the primary contributing factor was the lack of clarity in applying the standards. Judgment and the use of bright lines are much less frequently cited as the contributing factors.” The Sarbanes-Oxley Act had a significant influence on the findings as the portion of companies filing material weaknesses rose from 7% in 2003 to 47% in 2006.

The full report can be downloaded from the Social Science Research Network.