If an entity identifies error(s) in its previously issued financial statements, it needs to evaluate such error(s), both individually and in aggregate, to determine the future course of action. This document summarizes the applicable accounting and reporting guidance to assist in evaluating the materiality of error(s) identified in previously issued financial statements and how such errors are corrected.
The relevant guidance to use in this evaluation is as follows:
- Accounting Standards Codification (ASC) 250, Accounting Changes and Error Corrections
- Staff Accounting Bulletin (SAB) Topic 1.M, Materiality (SAB 99/ASC 250-10-S99)
- SAB Topic 1.N, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108/ASC 250-10-S99)
- S-X Rule 1-02, Definition of terms used in Regulation S-X
- Statement of Financial Accounting Concepts No. 8, Conceptual Framework for Financial Reporting – Chapter 3, Qualitative Characteristics of Useful Financial Information
- 2022 Speech from SEC’s then Acting Chief Accountant Paul Munter, Assessing Materiality: Focusing on the Reasonable Investor When Evaluating Errors
- Legal precedent
While some of the guidance noted above applies only to SEC registrants, it also provides a useful framework for other entities as they evaluate the impact of errors identified in their previously issued financial statements.
Materiality assessment requires significant judgment. If a material error is discovered in previously issued financial statements, the registrant must promptly correct those financial statements. If the error is immaterial, the financial statements may be corrected prospectively. Registrants apply the guidance in SAB Topic 1.N in conjunction with the guidance in ASC 250 and SAB Topic 1.M to determine how the error correction is reported. The following decision tree indicates the steps a company may consider when evaluating the correction of an error.
A decision flow chart illustrating how to assess materiality and determine the appropriate method for correcting financial statement errors.
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Kendra Decker is the national managing partner of Grant Thornton LLP’s Professional Practice within the firm’s Audit Quality and Risk group.
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Rohit Elhance is a partner in SEC Regulatory Matters group, with more than 17 years of international experience serving large multinational and entrepreneurial companies in the areas of audit, risk advisory and transaction services.
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Sandra Heuer is a partner in the Accounting Principles Group. Based in our Minneapolis office, she is also part of the National Professional Standards Group, where she has served eight years as a technical accounting resource to audit engagement teams.
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