Volume 16, No. 5

 

Out Of Sight, Out Of Mind: Staff Accounting Bulletin 108  Last September, the Securities & Exchange Commission's Office of the Chief Accountant issued Staff Accounting Bulletin No. 108 to provide guidance to companies in considering the materiality of known errors in financial statements issued in prior years. In most walks of adult life, it's understood: you make a mistake, you 'fess up and learn from it. Sticking with a mistake only seems to compound the consequences. So - why the need for regulatory "guidance" in deciding whether or not a financial reporting error needs a correction? Simple: after cultivating an aura of invincibility and precision ("earnings came in as targeted"), companies are loathe to admit an error for fear of looking dumb to investors. Another reason: when it comes to the plaintiff's bar, managers don't want to look like a pork chop waved in front of a coyote. Taking blame for flawed financial reporting can do that. The SEC has a ground-level view of what's under the financial statements; they know that companies have harbored errors in balance sheets for years. Issuing a Staff Accounting Bulletin on error corrections gets them aired, and gives companies some cover to get their sins cleansed "because they had to do it." SAB No. 108 has been little-noticed by investors, largely because in certain circumstances it permits the correction of errors by adjusting beginning-of-year retained earnings. It's not often that investors prowl the statement of changes in stockholders' equity, so they'll miss SAB 108 adjustments unless they notice their mention in the footnotes. There are some real differences in the way large companies and small companies have handled past errors and their corrections under SAB 108. Furthermore, investors who look at return on equity as a measure of operating performance can be misled by the SAB 108 "catch-up" treatment: error corrections that decrease equity can improve return on equity, perversely making companies with flawed reporting look like they're doing a better job with shareholder interests.

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