(Article from Registered Funds Regulatory Update, April 2022)
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On March 9, 2022, Paul Munter, SEC Acting Chief Accountant, released a statement discussing the SEC Staff’s views on evaluating the materiality of errors in previously-issued financial statements. Securities laws require public companies to provide investors with accurate financial statements that comply with generally accepted accounting principles (GAAP). If an error is identified in previously-issued financial statements, investors must be notified that the financial statements were flawed. The manner in which investors are informed of the error depends on whether the error is deemed material. In the statement, Munter asserted that registrants, auditors and audit committees should take a “well-reasoned, holistic, objective approach from a reasonable investor’s perspective based on the total mix of information” when assessing whether an error is material. This determination should take into account “all relevant facts and circumstances surrounding the error, including both quantitative and qualitative factors.”
If an error is deemed material, the registrant is required to correct the error and reissue the prior-period financial statements, which is referred to colloquially as a “Big R” restatement. If the error is not material to the prior-period financial statements but would be material to the current period, the registrant must still correct the error in the current financial statements by restating the prior-period information and disclosing the error. This method of error correction is referred to as a “little r” restatement.
Munter noted that while there was a decline in the total number of restatements from 2013 to 2020, the Staff observed an increase in the number of “little r” restatements. The Staff believes that this increase may be partly attributed to flawed materiality assessments that place more importance on qualitative factors. Munter highlighted the need for an unbiased objective analysis that is consistent with a reasonable investor’s perspective, especially when assessing qualitative factors. He noted that registrants using flawed processes end up correcting the error with a “little r” restatement when they should be reissuing the prior period’s financial statements. The Staff plans to continue monitoring restatement trends to learn more about how accounting errors are corrected and ensure registrants are providing investors with accurate financial statements.
Paul Munter, SEC Acting Chief Accountant, Assessing Materiality: Focusing on the Reasonable Investor When Evaluating Errors (Mar. 9, 2022), available at: https://www.sec.gov/news/statement/munter-statement-assessing-materiality-030922.