Corporate Financial Restatements
How do we know? What should we do?

A very interesting question came in from a club that had owned a stock a few years ago and in doing a stock update, found that the financial information they had used for earlier evaluations was now changed. They were wondering why this would happen and how they should have been informed about it.

Accounting is not as black and white as it might seem. There are a variety of judgments which go into the information presented in many of the accounting categories that you see on financial statements. There are official guidelines on how to make these judgments and auditors that oversee the application of them but there are reasons that certain things may come to light after statements are released. Sometimes the financial statements need to be revised.

Restatements must be described in the notes to the financial statements in the quarter in which they occur and in every subsequent quarter up to and including the annual report. In the section called "Notes to the Financial Statements", you should see a description of what happened and what changes were made. Usually, any prior year comparison information is adjusted also. A company has to file a form called an 8-K whenever anything of material impact changes in between regular reports. You should keep an eye on the news headlines and briefly check those out whenever they happen.

Consider a restatement a strong reason to do some more research. A restatement can affect the judgements you have used to project returns for a stock. Determine what changed and why the change was made. There are many reasons for a restatement. It could have been due to a mistake, a change in the judgments used to develop an estimate, application of a new accounting rule or a change that didn't happen until after reports were released that affected prior year information. It could be that management felt that they preferred a different method to track their business and present their operations (such as changing the way they value their inventory). They need to disclose and get changes in methods approved but they can make them.

This is another good reason to start to get comfortable with looking at financial statements and deciding for yourself whether you are comfortable with the way a company is being managed and with the information they are providing you.

Club Activity

Look at the annual report for one of the companies your investment club holds or is thinking of investing in. Annual reports are sent to you each year if you own a stock. You can also contact the investor relations department of the company and they will send you one. Of course, these days, most are also found online. Either go to the investor relations section of the company website or go to finance.yahoo.com and select SEC filings from the column on the left. The annual report is the 10-K filing. Quarterly reports are 10-Q

Find the section in the annual report labeled something like "Notes to Financial Statements". This is where you should find accounting changes discussed. If there are any noted, what amounts changed? Did it affect the numbers you used in the past to project sales and earnings growth or to evaluate Return on Equity or Debt/Capital ratios? Are you comfortable with the change and the description or do you think it might be a reason to reassess holding the stock? If you have specific questions about specific changes, bring up the question on club cafe or email us at support@bivio.com and we can help you look into it.