2005 will be the ‘Year of the Restatement,’ due to new global accounting standards and new internal control reporting rules in the United States, warns Fitch Ratings.

The rating agency expects numerous financial restatements as thousands of companies outside the U.S. switch from local accounting standards to International Financial Reporting Standards (IFRS) and restate their 2004 balance sheets.

For U.S. companies Fitch anticipates many accounting restatements when 2004 annual financial statements are reported resulting from the first year of enforcement of Sarbanes Oxley Section 404 (SOX 404) combined with a reinvigorated auditing profession operating under the watchful eye of the Public Company Accounting Oversight Board. These factors are resulting in more rigorous interpretation and reevaluation of the way financial standards are applied, it notes.

“While restatements are usually received by the market as a ‘negative’, overall this exercise should be positive for investors,” it says. “However, implementation of the new accounting regime is not without risk.”

“Investors are going to have to take a close look at restatements to determine if the new numbers are merely a different way of saying what they already knew, or whether a new underlying message has been revealed,” said report co-author Bridget Gandy.

The report warns of several accounting risk drivers in 2005 including:

  • the adoption of IFRS will create many challenges as companies make transition from local accounting standards to international standards;
  • increased accounting adjustments are surfacing with implementation of SOX 404;
  • the SEC has made it clear that improved disclosure and transparency is paramount;
  • derivatives remain an area of extreme complexity that raises the risk of restatements;
  • assumptions regarding defined benefit pension plans and healthcare costs will continue to be a 2005 headline issue, and for many companies IFRS will bring additional pension liabilities onto the balance sheet;
  • the recent rise in M&A activity in the US heightens the risk of internal control breakdowns, potentially aggressive accounting and restatement risk; and
  • standard setters are moving to more ‘fair value’ revenue recognition creating challenges in reconciling earnings to cash flow.