Evaluation and Correction of Errors Identified from the Quantification of Misstatements Associated with the Carryover or Reversing Effects of Prior Year Misstatements on Current Year Financial Statements
Last Updated: August 16, 2007 (Updated sections are indicated with an asterisk *)
The staff has prepared this summary of Board decisions for information purposes only. Those Board decisions are tentative and do not change current accounting. Official positions of the FASB are determined only after extensive due process and deliberations.
The Financial Accounting Standards Board (FASB) has added to its agenda a project to address the process of quantifying misstatements in current-year financial statements arising from the carryover or reversal of prior-period errors for the purpose of evaluating materiality.
On March 13, 2007, the Board published the following Exposure Draft. The comment period for the Exposure Draft was 45 days and ended on April 30, 2007. The Exposure Draft, comment letters, and comment letter summaries can be accessed using the links below.
At the August 1, 2007 Board meeting, the Board began its redeliberations on the proposed FASB Staff Position 154-a, “Considering the Effects of Prior-Year Misstatements When Quantifying Misstatements in Current-Year Financial Statements.” At that meeting, the Board decided not to issue a final FSP and removed the project from its agenda.
The Board meeting minutes are provided for the information and convenience of constituents who want to follow the Board’s deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions become final only after a formal written ballot to issue a final Statement, Interpretation, or FSP.
|*August 1, 2007||Board Meeting—Comment letter analysis|
|December 19, 2006||Board Meeting—Agenda decision|
On September 13, 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. The SEC identified two methods that were being used to quantify current-year misstatements resulting from the carry-over or reversal of prior-year misstatements.
Method 1, the rollover approach, looks at the amount by which the current-year income statement is misstated. This method ignores the effects of correcting the portion of the current-year balance sheet misstatement that originated in prior years. By looking at materiality relative to just the income statement, the errors on the balance sheet can accumulate over time. According to the SEC, some registrants using the rollover approach concluded that the improper asset or liability should remain on the balance sheet in perpetuity.
Method 2, the iron curtain approach, looks at the cumulative amount by which the balance sheet is misstated to determine materiality. This method ignores the effect on the current-year income statement caused by the balance sheet correction. It does not consider the effect on the current-year income statement to be an error.
Through SAB 108, the SEC requires registrants to quantify misstatements using both the rollover and iron curtain approaches. If either method results in a material error, the financial statements must be adjusted.
SAB 108 provides guidance for correcting misstatements. If adjustments resulting from the application of the SAB affect prior-year statements, those statements must be corrected. This is true even when the misstatements are immaterial. However, on initial adoption, the SEC will permit a cumulative-effect adjustment rather than requiring a restatement of the prior-year financial statements. This is permitted if management properly applied either approach in the past and, considering all relevant qualitative factors, determined that the errors were not material.
The FASB received inquiries about the application of SAB 108 to the private sector. Public companies must adhere to the requirements set forth in SAB 108. Private companies are not bound by SAB 108. As a result, concern was expressed that diversity will exist in the private sector relating to the determination of materiality associated with errors caused by the carry-over or reversal of prior-year misstatements.