Accounting/tax question about restating earnings

[alebron]

Many companies are restating earnings now as a result of options backdating issues. I have a few questions about the mechanics.

1. If company A restates earnings such that they earned 1M less than they claimed they did, what happens to the balance sheet? Owner's equity (in the form of retained earnings) goes down by 1M, but what else compensates? Assets go down, or (seems more plausible) liabilities go up. Which is it? What _exactly_ happens here?

2. Seems to me that if you're usually restating earnings down, you should be owed back taxes by the IRS, not be liable to additional taxation (as it seems most companies are).

[DcifrThs]

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Many companies are restating earnings now as a result of options backdating issues. I have a few questions about the mechanics.

1. If company A restates earnings such that they earned 1M less than they claimed they did, what happens to the balance sheet? Owner's equity (in the form of retained earnings) goes down by 1M, but what else compensates? Assets go down, or (seems more plausible) liabilities go up. Which is it? What _exactly_ happens here?

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i'm no expert here, but accounting for options as expenses implies that the shares onw hich they are based are then real somehow and that would offset the decrease in owners' equity on the liability side of the balance sheet.

again, not really sure but just offering one thought on how it would play out. in any case, i'm virtually positive it has SOMETHING to do with the way the shareholders equity section of the liabilities side of the balance sheet is calculated and how that would offset the decrease in RE.

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2. Seems to me that if you're usually restating earnings down, you should be owed back taxes by the IRS, not be liable to additional taxation (as it seems most companies are).

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what do you mean "not be liable to additional taxation (as it seems most companies are)"?

in any case, i'm again no expert but pretty sure you (a corporation) get carryforwards based on overpaid taxes as a result of earnings restatements (assuming those restatements are to the downside and not criminal or something). so your future tax liabilities should come down by the amount of the tax overpayment.

Barron

[bobman0330]

Stock options aren't taxed at issue, nor does the employer get a deduction, so any restatements about value will be tax-neutral.

[RicoTubbs]

1. It should be confined to the Equity section. When employees work, their compensation costs are expenses on the Income Statement, which reduces net income, which flows through the Balance Sheet into Retained Earnings. So for every additional dollar of compensation (forget taxes), Retained Earnings goes down by $1. The corresponding effect depends on the type of compensation. If it's cash, obviously Assets will decrease. If it's equity (restricted stock or options, for example), equity will increase - it's more or less a capital contribution by employees. Net result of granting options is an increase in Contributed Capital and a decrease in Retained Earnings.

That's specific to restating earnings due to improper accounting for options. Obviously, firms restate for any number of reasons. So if you're looking for a general answer about the other side of the equation (in addition to Retained Earnings), it will depend on the cause of the restatement.

2. Tax accounting and financial accounting are distinct. Restatement of one does not necessarily lead to restatement of the other. There is evidence, though, that firms committing financial statement fraud were willing to pay taxes on their fraudulent earnings in order to keep up the masquerade.