James H. Thompson

AN ANALYSIS OF RESTATEMENTS ON FINANCIAL REPORTING: IS THE LOSS OF INVESTOR CONFIDENCE JUSTIFIED?

Public confidence in financial statements may be at an all-time low. The bankruptcy of Enron, the largest bankruptcy in United States history, brings into question whether the accounting profession, and the auditing process in particular, protects the users of financial statements. The shower of scandals and earnings restatements makes users skeptical of the financial reporting rules that are supposed to protect the public. In addition, a lack of transparency in reporting followed by restated financial restatements disclosing billions of dollars of omitted liabilities and losses exacerbate this problem. This paper considers the frequency and nature of Form 8-K reports that are filed with the Securities and Exchange Commission (SEC) by Fortune 500 companies during 2001. This form is used to report the occurrence of any material events or corporate changes which are of importance to investors or security holders and previously have not been reported by the registrant. Information from Form 8-K is analyzed to identify which companies filed 8-K reports, the types of disclosures that are included, industry characteristics of companies that file 8-K reports, whether financial statements were restated as a result of those filings, the reasons that restatements, if any, were required, and the relationship between size of company and number of restatements.

An Alternative Approach for Controlling Statistical Audit Sampling Risks

Traditional approaches to risk control used for planning, executing, and evaluating substantive audit tests focus primarily on the risk of accepting a materially misstated amount (β risk) and only consider passively the risk of rejecting a correctly stated amount (α risk). This article discusses an alternative – the trade‐off approach – that formally considers both risks. Although the traditional and the trade‐off approach frequently lead to the same statistical conclusion, there are some applications in which only the trade‐off approach, can provide a statistical conclusion in support of the auditor′s assertion that a client′s balance is correctly stated. The article identifies these applications and suggests that the trade‐off approach merits further consideration.

Accounting for the New Market in Life Insurance

The accounting for life insurance contracts purchased by third parties changed dramatically with the issuance of an FASB Staff Position (FSP) on FASB Technical Bulletin 85-4. This FSP provides initial and subsequent measurement guidance and financial statement presentation and disclosure guidance for investments by third-party investors in life settlement contracts. An investor must now elect to account for its investments in life settlement contracts using either the investment method or the fair value method. However, this election is irrevocable. Thus, investors must carefully choose between the two methods. Under the investment method, investments in life insurance are recorded initially at the cost of acquisition and subsequently increased for premiums paid to keep the policy in force; however, no income from the policy is recorded until death of the insured. Under the fair value method, investments in those policies are also adjusted for changes in fair value over the life of the policy. Under both methods, income is recognized at the death of the insured that is equal to the difference between death proceeds and the carrying amount of the policy. Under the former cash surrender value method, income at death of the insured was based on the death proceeds and a policys cash surrender value, often zero. Since the methods differ in the manner for measuring income, investors need to understand the implications of choosing between the two methods. This paper presents empirical evidence that should aid an enterprise in making the appropriate election.