The coronavirus 2019 (COVID-19) pandemic has brought major disruptions worldwide, with further impacts yet to be felt. For many businesses, operations are curtailed or dramatically shifted, and supply chains are disrupted. New regulatory and operating guidance is issued daily, with a fair amount of it impacting financial accounting and reporting. For example, the SEC just issued an announcement that it is extending filing guidelines and providing other reporting relief for certain covered entities, and the Commission’s Division of Corporate Finance issued separate guidance regarding expected disclosures and accounting considerations.
While COVID-19’s impacts vary by industry, all businesses will want to re-evaluate their accounting, reporting and disclosure, as well as Internal Controls Over Financial Reporting (ICOFR) practices, in light of the pandemic.
Finance and accounting leaders should focus on these potential accounting and audit impacts:
- Impairment of goodwill — Assess whether direct or indirect implications of COVID-19 have led to a goodwill impairment. Future cash flow expectations may be affected by COVID-19 if its disruptive effects are sustained. If they are, this would requires companies, in the light of this so-called “triggering event,” to evaluate whether a reporting unit’s fair value has degraded below its carrying amount.
- Impairment of long-lived assets — Consider whether any current, significant devaluation of long-lived assets is recoverable. Indicators, such as significant drops in price, sustained adverse changes in use or utility of an asset, negative changes in business climate or downward economic pressures, should prompt impairment assessments of long-lived assets.
- Inventories — net realizable value — If the company has suffered revenue declines or disrupted supply chains, consider adjusting the carrying value of inventory downward. Losses may result from exceeding expiration or sell-by dates, physical deterioration, obsolescence, or price changes. Perishables, products with shorter shelf lives or expiration dates, or specific seasonal inventories are most at risk. Book the loss in the same period the decline occurs.
- Inventories — reduced manufacturing levels and excess capacity costs — If manufacturing drops below standard levels due to labor or material shortages, consider cost-of-inventory impacts. Underutilized capacity resulting in excess fixed overhead that can’t be allocated to products must be expensed in the same period it’s incurred.
- Impairment of receivables, loans and investments — Review investment value for potential impairment. This may be indicated with debt or equity issuers affected by COVID-19. Specific rules for testing for impairment are based on an investment instrument’s classification under GAAP.
Financial institutions that are SEC fliers have been transitioning from an Incurred Loss model to a Current Expected Credit Loss (CECL) model and were expected to record their losses using the new model in their first-quarter filings; however, the Coronavirus Aid, Relief, and Economic Security (CARES) Act has relaxed the effective date and stipulates that “no insured depository institution, bank holding company, or any affiliate thereof shall be required to comply” with CECL during the national emergency, until as late as December 31, 2020. With deferral of CECL implementation, some financial institutions need to decide whether to revert to the Incurred Loss framework, or continue with CECL. Other entities, not subject to the relief afforded certain financial institutions, as noted above, will need to continue with the new standard on the original calendar trajectory.
- Fair value measurement (FVM) — Consider market prices in valuation assessments, even when uncertainty and volatility in the markets suggest that published prices are outliers.
- Debt modifications and loan covenants — Assess whether additional or bridge financing, restructuring of existing debts, or covenant waivers that address decreased revenues, higher operating costs or cash flow challenges represent debt modifications, extinguishments, or troubled debt restructuring. Each has specific accounting and reporting implications. If covenants are breached, reclassing debt from-long term to current may be required.
- Revenue recognition – Assess the value of variable considerations (i.e., discounts, refunds, price concessions, performance bonuses and penalties) inherent in customer contracts. Businesses are required to estimate what consideration (including potential variable consideration) they will be entitled to for transferring promised goods or services at contract inception. Update these estimates at each reporting date. These evaluations must reflect current economic realities due to COVID-19.
- Subsequent events recognition and disclosure — Evaluate information that becomes available after balance sheet dates — but before the issuance of the financial statements — at the end of each reporting period. GAAP requires entities either to disclose an event’s nature and estimated financial statement impact, or to declare that an assessment can’t be made. The SEC recently stressed the importance of ensuring the sufficiency of subsequent-events disclosures. While COVID-19’s impact was a non-accrual subsequent event for calendar-year-reporting companies when they issued statements, the pandemic will likely trigger increased accounting and disclosure impacts in ongoing 2020 SEC filings.
SEC registrants must also address COVID-19’s impacts in annual or periodic filings, in two main areas:
- Risk factors — Beyond general risks related to potential natural disasters, consider a risk factor update specific to COVID-19, and provide details about its potential negative impacts on business.
- Management discussion and analysis (MD&A) — Disclose known trends or uncertainties that have (or could have) material impact on revenues or income. Include disclosures about COVID-19’s current and potential future impacts on operations, financial condition and liquidity. These disclosures could provide information on expected revenue declines or lower profit margins, while also foreshadowing potential future asset impairments or financial statement losses.
COVID-19 also prompts reevaluation of these internal control considerations:
- Control environment changes — SEC rules dictate that significant changes to the ICOFR infrastructure be disclosed in quarterly and annual filings. These include internal control environment changes, like remote working arrangements and the potential inherent risk of controls not being executed as designed.
- Assessing operating effectiveness — Assess controls’ operating effectiveness, including management review controls. Reevaluate control procedures’ effectiveness due to remote work, facility closure, illness and other gaps. Identify alternative controls or other mitigation when existing controls can’t be performed.
- Financial reporting operating resiliency — Assess the business’ capability to prepare financial statements completely, accurately and timely. Pandemic-related risk indicators include subsidiary locations in lockdown, attrition or illness of qualified personnel, and facilities or financial reporting hubs functioning remotely or going offline.
Current news coverage of COVID-19 indicates we are still approaching the peak of its effects on global financial markets. COVID-19’s impacts will differ for each organization. Finance leaders should remain focused, pay attention to changes and reassess their accounting and reporting practices as they respond to the pandemic and its consequences.