Level 3 Reporting Quality: Trend Analysis of Derivative Instruments? Restatements

This paper addresses the area of financial restatements in the field of derivatives and hedging.  First, the concept of the fair value hierarchy is discussed to set the stage for the analysis conducted. We explained what Level 3 derivatives are and their lack of transparency. Afterwards, we described the differences between the financial usage of the term derivatives versus the accounting definition per Accounting Standard Codification (ASC) 815. This distinction will have an impact on the analysis as our research will be limited to the accounting definition. Afterwards, a literature review was conducted to gain the latest research in fair value accounting and Level 3 financial reporting. The authors then proceeded to conduct research governing trends in financial restatements and to ascertain the particular areas of weaknesses in derivative methodologies. There were several findings noted:1) The small market capitalization companies had more restatements than the larger capitalization companies, 2) As expected, financial services led the way with most restatements in the derivatives/hedging area, and 3) There is a decreasing trend with restatements with regards to derivatives/hedging. With the information gathered from this research, we will direct our research into interest rate derivatives and attempt to ascertain the flaws noted in this particular arena.