Financial Audit:

Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users

GAO-07-91: Published: Oct 5, 2006. Publicly Released: Oct 5, 2006.

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GAO continues to have concerns about restatements to federal agencies' previously issued financial statements. During fiscal year 2005, at least 7 of the 24 Chief Financial Officers (CFO) Act agencies restated certain of their fiscal year 2004 financial statements to correct misstatements. To study this trend, GAO reviewed the nature and causes of the restatements made by certain CFO Act agencies in fiscal year 2004 to their fiscal year 2003 financial statements. Eleven CFO Act agencies had restatements for fiscal year 2003. Nine of those 11 received unqualified opinions on their originally issued fiscal year 2003 financial statements. GAO's view is that users of federal agencies' financial statements and the related audit reports need to be provided at least a basic understanding of why a restatement was necessary and its effect on the agencies' previously issued financial statements and related audit reports. This report communicates GAO's observations on the transparency and timeliness of the 9 federal agencies' and their auditors' restatement disclosures.

The nine agencies GAO reviewed did not consistently communicate financial statement restatements. GAO found that all nine agencies could have greatly enhanced the adequacy, effectiveness, and timeliness of their restatement disclosures to users. Similar transparency issues existed with the associated audit reports regarding disclosure of all the essential information that would clearly explain the restatements. GAO highlighted the following issues as among the more prevalent issues to be addressed: 1) columns of the agencies' restated financial statements were not labeled as "Restated"; 2) agencies' restatement footnote disclosures lacked clarity or sufficient detail regarding the nature of the restatements and the effect on balances reported in previously issued financial statements; 3) restatement information was not sufficiently disclosed in the agencies' Management Discussion and Analysis; 4) audit reports did not disclose that the respective agencies had restated certain of their fiscal year 2003 financial statements; 5) audit reports did not provide a statement that the previously issued audit report was withdrawn and replaced by the opinion on the restated financial statements; and 6) material misstatements and potential material misstatements were not timely communicated by agencies to either their auditors or to the users of the financial statements. The primary contributing factor for the restatement disclosure issues that GAO identified was insufficient guidance available at the time to both the agencies' management and their respective auditors for disclosure of the restatements and the timeliness of such disclosures. GAO believes that information regarding restatements should be disclosed in a transparent and timely manner consistent with the qualitative characteristics of information in financial reports described in Statement of Federal Financial Accounting Concepts (SFFAC) No. 1. In GAO's view, more detailed accounting and auditing guidance on how to satisfy the financial reporting characteristics as outlined in SFFAC No. 1 as it relates to the disclosure of restatements would have been helpful. OMB revised Circular No. A-136, Financial Reporting Requirements, which provides additional guidance to federal agencies' management regarding disclosure of restatements to previously issued financial statements. Revisions made to OMB Circular No. A-136 address many of GAO's concerns regarding the agencies' disclosure of restatements. In addition, the proposed 2006 revision of generally accepted government auditing standards now includes a section on reporting on restatement of previously issued financial statements. In addition, on August 23, 2006, OMB issued Bulletin No. 06-03, which also provides some information regarding reporting on restatements. However, GAO believes that OMB needs to timely provide additional, though complementary, restatement guidance to both the agencies' management and their respective auditors.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: On October 5, 2006, we issued report GAO-07-91, Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users, which summarized our review of the nature and causes of fiscal year 2003 financial statement restatements made by nine CFO Act agencies. In this report, we noted inconsistencies in restatement disclosures among the nine agencies we reviewed. The primary contributing factor for the inconsistent restatement disclosure issues that we identified was insufficient guidance on the nature and timing of reporting such restatements. Our report included numerous recommendations to improve the restatement guidance available to agencies' management. One of these recommendations directed the Office of Management and Budget (OMB) to add a requirement to OMB Circular No. A-136, Financial Reporting Requirements, for federal agencies restating their previously issued financial statements to clearly label such financial statements as "Restated." In response to our recommendation, OMB included this requirement in its June 2007 revision of OMB Circular No. A-136. As a result, federal agencies' reporting on restatements of previously-issued financial statements will be improved.

    Recommendation: OMB should add the following requirement to sections II.4.3.1, II.4.4.1, II.4.5.1, II.4.6.1, and II.4.7.1 of OMB Circular No. A-136, Financial Reporting Requirements: Agencies shall label restated financial statements as "Restated."

    Agency Affected: Executive Office of the President: Office of Management and Budget

  2. Status: Closed - Implemented

    Comments: On October 5, 2006, we issued report GAO-07-91, Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users, which summarized our review of the nature and causes of fiscal year 2003 financial statement restatements made by nine CFO Act agencies. In this report, we noted inconsistencies in restatement disclosures among the nine agencies we reviewed. The primary contributing factor for the inconsistent restatement disclosure issues that we identified was insufficient guidance on the nature and timing of reporting such restatements. Our report included numerous recommendations to improve the restatement guidance available to agencies' management. One of these recommendations directed the Office of Management and Budget (OMB) to clarify guidance in OMB Circular No. A-136, Financial Reporting Requirements, to provide that agencies' Statement of Changes in Net Position's current year's unadjusted beginning balances should agree with any restated ending balances on the agency's prior year's Statement of Changes in Net Position. In response to our recommendation, OMB included this clarification in its June 2007 revision of OMB Circular No. A-136. As a result, federal agencies' reporting on restatements of previously-issued financial statements will be improved.

    Recommendation: OMB should add the following requirement to the "Corrections of Errors" subsection of section II.4.5.5 of OMB Circular No. A-136, Financial Reporting Requirements: The Statement of Changes in Net Position's current year's unadjusted beginning balances shall agree with the restated ending balances on the agency's prior year's Statement of Changes in Net Position.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  3. Status: Closed - Implemented

    Comments: On October 5, 2006, we issued report GAO-07-91, Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users, which summarized our review of the nature and causes of fiscal year 2003 financial statement restatements made by nine CFO Act agencies. In this report, we noted inconsistencies in restatement disclosures among the nine agencies we reviewed. The primary contributing factor for the inconsistent restatement disclosure issues that we identified was insufficient guidance on the nature and timing of reporting such restatements. Our report included numerous recommendations to improve the restatement guidance available to agencies' management. One of these recommendations directed the Office of Management and Budget (OMB) to clarify OMB Circular No. A-136, Financial Reporting Requirements, guidance for federal agencies concerning disclosure of the nature of errors resulting in restating previously issued financial statements. In response to our recommendation, OMB clarified guidance regarding disclosing the nature of errors resulting in financial statement restatements in its June 2007 revision to OMB Circular No. A-136. As a result, federal agencies' reporting on restatements of previously-issued financial statements will be improved.

    Recommendation: OMB should revise section II.4.10.43, of OMB Circular No. A-136, Financial Reporting Requirements, to clarify the definition of the "nature" of an error.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  4. Status: Open

    Comments: OMB has not yet updated Circular A-136 for this language.

    Recommendation: OMB should add the following requirement to section II.2.7 of OMB Circular No. A-136, Financial Reporting Requirements, which discusses guidance for information included in the Management Discussion and Analysis (MD&A): Agency's management shall disclose the existence of restatements in its MD&A if the agency asserts in its MD&A that it received an unqualified opinion on any previously issued financial statement and that respective financial statement was subsequently restated.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  5. Status: Closed - Implemented

    Comments: We recommended that the Office of Management and Budget (OMB) provide additional guidance in OMB Bulletin No. 06-03, "Audit Requirements for Federal Financial Statements," on how agency auditors should advise agency management with respect to material misstatement(s) or potential material misstatement(s) concerning previously issued financial statements. In response to our recommendation, OMB included additional guidance in its September 2007 revision of the Audit Requirements for Federal Financial Statements, OMB Bulletin No. 07-04, which supersedes OMB Bulletin No. 06-03. As a result, if followed, users of these financial statements should be better, and more timely, informed as to any such restatements and therefore better able to make an assessment of the reliability of those statements.

    Recommendation: OMB should modify section 5.2 of OMB Bulletin No. 06-03, Audit Requirements for Federal Financial Statements, to read as follows: 5.2 The nature or amount of known or likely misstatement(s) in previously issued audited financial statement(s) may lead the auditor to believe that the auditor's report would or could reasonably have been affected if the auditor had known of the misstatement(s) when the auditor issued the auditor's report. When this condition exists, the auditor shall advise management to communicate the following information to those charged with governance, oversight bodies, funding agencies, and others who are relying or are likely to rely on the financial statement(s): the nature and cause(s) of the known or likely material misstatement(s), the amount(s) of known or likely material misstatement(s) and the related effect(s) on the previously issued financial statement(s) (e.g., disclosure of the specific financial statement(s) and line item(s) affected). If this information is not known, then the disclosure includes information that is known and a statement that management cannot determine the amount(s) and the related effect(s) on the previously issued financial statement(s) without further investigation, and a notice that (1) a previously issued financial statement(s) will or may be restated and, therefore, (2) the related auditor's report is no longer reliable. This includes communication (1) in writing to the Congress, OMB, Treasury, and GAO; (2) to the public on the Internet pages where the agency's previously issued financial statements that were affected by the material misstatement(s) or potential material misstatement(s) are published; and (3) to OMB in the agency's next quarterly financial statements and in subsequent quarterly financial statements until the specific amount(s) of the material misstatement(s) and the related effect(s) of such on the previously issued financial statement(s) are known and reported.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  6. Status: Closed - Implemented

    Comments: We recommended that the Office of Management and Budget (OMB) provide additional guidance in OMB Bulletin No. 06-03, "Audit Requirements for Federal Financial statements," on how agency auditors should disclose a restatement in their audit report. In response to our recommendation, OMB included such guidance in its September 2007 revision of the Audit Requirements for Federal Financial Statements, OMB Bulletin No. 07-04, which supersedes OMB Bulletin No. 06-03. As a result, if effectively implemented, the auditors' restatement disclosures and the timeliness of such disclosures should be improved.

    Recommendation: OMB should modify section 7.7 of OMB Bulletin No. 06-03, Audit Requirements for Federal Financial Statements, to read as follows: 7.7 When management restates a previously issued financial statement(s), the auditor shall perform audit procedures sufficient to reissue or update the auditor's report on the restated financial statement(s). The auditor shall fulfill these responsibilities whether the restated financial statement(s) are separately issued or presented on a comparative basis with those of a subsequent period. The auditor shall include the following information in an explanatory paragraph in the reissued or updated auditor's report on the restated financial statement(s): a statement disclosing that a previously issued financial statement(s) has been restated, a statement that the previously issued financial statement(s) was materially misstated and that the previously issued auditor's report (including report date) is withdrawn and replaced by the auditor's report on the restated financial statement(s), a reference to the note(s) to the restated financial statement(s) that discusses the restatement, a description of the following if not already provided in the note(s) to the financial statement(s): (1) the nature and cause(s) of the misstatement(s) that led to the need for restatement and (2) the specific amount(s) of the material misstatement(s) and the related effect(s) on the previously issued financial statement(s) (e.g., year(s) being restated and the specific financial statement(s) affected and line items restated) and the impact on the financial statements as a whole (e.g., change in overall net position, change in the audit opinion), and a discussion of any significant internal control deficiency that failed to prevent or detect the misstatement and what action management has taken about the deficiency.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  7. Status: Closed - Implemented

    Comments: We recommended the Office of Management and Budget (OMB) provide additional guidance in OMB Bulletin No. 06-03, "Audit Requirements for Federal Financial Statements," on how agency auditors should report on an agency's material misstatement(s) or potential material misstatement(s) concerning previously issued financial statements when the specific amount(s) and related effect(s) are unknown. In response to our recommendation, OMB included such guidance in its September 2007 revision of the Audit Requirements for Federal Financial Statements, OMB Bulletin No. 07-04, which supersedes OMB Bulletin No. 06-03. As a result, if effectively implemented, users of federal financial statements will have better information as a result of these improvements in auditors' reporting on financial statement restatement disclosures.

    Recommendation: OMB should add the following requirements to section 7 of OMB Bulletin No. 06-03, Audit Requirements for Federal Financial Statements, as follows: 7.8 If at the time of issuance of the auditor's report a material misstatement(s) or potential material misstatement(s) has been identified in any of the previously issued financial statements and the specific amount(s) of the misstatement(s) and the related effect(s) of such are not known, then the auditor shall update the auditor's report on the previously issued financial statement(s) as appropriate. Furthermore, the auditor's report shall disclose, at a minimum, the following: a statement disclosing that a material misstatement(s) or potential material misstatement(s) affects a previously issued financial statement(s) but the specific amount(s) of the misstatement(s) and the related effect(s) of such are not known; a reference to note(s) to the financial statements that discusses the restatement or potential restatement; a description of the following, if not already provided in the agency's note(s) to the financial statements: (1) the nature and cause(s) of the misstatement(s) or potential misstatement(s), and (2) an estimate of the magnitude of the misstatement(s) or potential misstatement(s) and the related effect(s) of such on a previously issued financial statement(s) (e.g., disclosure of the specific financial statement(s) and line items affected) that are known and a statement that the specific amount(s) and the related effect(s) of such cannot be determined without further investigation; and a statement disclosing that a restatement(s) to a previously issued financial statement(s) will or may occur.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  8. Status: Closed - Implemented

    Comments: On October 5, 2006, we issued report GAO-07-91, Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users, which summarized our review of the nature and causes of fiscal year 2003 financial statement restatements made by nine CFO Act agencies. In this report, we noted inconsistencies in restatement disclosures among the nine agencies we reviewed. The primary contributing factor for the inconsistent restatement disclosure issues that we identified was insufficient guidance on the nature and timing of reporting such restatements. Our report included numerous recommendations to improve the restatement guidance available to agencies' management. One of these recommendations directed the Office of Management and Budget (OMB) to clarify guidance in OMB Circular No. A-136, Financial Reporting Requirements, on reporting actions federal agencies should take when a material misstatement(s) or potential material misstatement(s) affecting a previously issued financial statement(s) is identified. In response to our recommendation, OMB included such clarification in its June 2007 revision of OMB Circular No. A-136. As a result, federal agencies' reporting on restatements of previously-issued financial statements will be improved.

    Recommendation: OMB should modify the "Management Actions Related to Corrections of Errors" subsection of section II.4.5.5 of OMB Circular No. A-136, Financial Reporting Requirements, to include requirements for how an agency's management shall disclose material misstatement(s) or potential material misstatement(s) affecting a previously issued financial statement(s).

    Agency Affected: Executive Office of the President: Office of Management and Budget

  9. Status: Closed - Implemented

    Comments: We recommended the Office of Management and Budget (OMB) provide additional guidance in OMB Bulletin No. 06-03, "Audit Requirements for Federal Financial Statements," on actions agency auditors should take when reviewing the timing and adequacy of an agency's disclosure of a material misstatement(s) or potential material misstatement(s) affecting previously issued financial statements. In response to our recommendation, OMB included such guidance in its September 2007 revision of the Audit Requirements for Federal Financial Statements, OMB Bulletin No. 07-04, which supersedes OMB Bulletin No. 06-03. As a result, if effectively implemented, the consistency of federal agency auditors' reporting on the nature and timing of restatements of previously-issued financial statements should be improved.

    Recommendation: OMB should add requirements to section 5 of OMB Bulletin No. 06-03, Audit Requirements for Federal Financial Statements, regarding (1) the auditor's review of the agency's management disclosure of material misstatement(s) or potential material misstatement(s) affecting a previously issued financial statement(s); (2) how the auditor should advise the agency's management if a material misstatement(s) or potential material misstatement(s) affecting a previously issued financial statement(s) is identified; and (3) the steps the auditor should take if the auditor determines that the agency did not adequately timely notify the financial statement users.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  10. Status: Closed - Implemented

    Comments: On October 5, 2006, we issued report GAO-07-91, Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users, which summarized our review of the nature and causes of fiscal year 2003 financial statement restatements made by nine CFO Act agencies. In this report, we noted inconsistencies in restatement disclosures among the nine agencies we reviewed. The primary contributing factor for the inconsistent restatement disclosure issues that we identified was insufficient guidance on the nature and timing of reporting such restatements. Our report included numerous recommendations to improve the restatement guidance available to agencies' management. One of these recommendations directed the Office of Management and Budget (OMB) to improve guidance in OMB Circular No. A-136, Financial Reporting Requirements, concerning disclosures related to federal agencies restating their previously issued financial statements to disclose restated specific line items and related amounts. In response to our recommendation, OMB included improved guidance in its June 2007 revision of OMB Circular No. A-136. As a result, federal agencies' reporting on restatements of previously-issued financial statements will be improved.

    Recommendation: OMB should revise section II.4.10.43, of OMB Circular No. A-136, Financial Reporting Requirements, to include an explanation that the disclosure of the "amounts being restated" specifically refers to the disclosure of the specific line items restated and the related amounts.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  11. Status: Closed - Implemented

    Comments: On October 5, 2006, we issued report GAO-07-91, Restated Financial Statements: Agencies' Management and Auditor Disclosures of Causes and Effects and Timely Communication to Users, which summarized our review of the nature and causes of fiscal year 2003 financial statement restatements made by nine CFO Act agencies. In this report, we noted inconsistencies in restatement disclosures among the nine agencies we reviewed. The primary contributing factor for the inconsistent restatement disclosure issues that we identified was insufficient guidance on the nature and timing of reporting such restatements. Our report included numerous recommendations to improve the restatement guidance available to agencies' management. One of these recommendations directed the Office of Management and Budget (OMB) to clarify in OMB Circular No. A-136, Financial Reporting Requirements, guidance on required disclosures related to federal agencies' actions taken following discovery of errors in previously issued financial statements. In response to our recommendation, OMB included this clarification in its June 2007 revision of OMB Circular No. A-136. As a result, federal agencies' reporting on restatements of previously-issued financial statements will be improved.

    Recommendation: OMB should revise section II.4.10.43, of OMB Circular No. A-136, Financial Reporting Requirements, to clarify how an agency should specifically further discuss the actions management took after discovering the error.

    Agency Affected: Executive Office of the President: Office of Management and Budget

 

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