Do Type II Subsequent Events Impair Financial Reporting Quality?

This study examines whether material corporate events that occur during the year-end closing process constrain management's and the auditor's resources and inhibit them from providing high quality financial reports. For a sample of U.S. company financial reports issued during 2000–2013, we identify material corporate events using Type II subsequent event footnote disclosures (i.e., material events that occur in year t+1, but prior to the issuance of the year t financial statements, yet do not affect amounts recognized in year t). We find that Type II subsequent events are associated with lower financial reporting quality as measured by the need to subsequently restate the year t financial statements. The increased restatement likelihood only occurs when managers are resource constrained. Auditors can mitigate the increased restatement risk but only when they allocate more resources to the engagement. Our results underscore the importance of resource management in the financial reporting and audit processes