Recent guidance from the Division of Corporate Finance at the Securities and Exchange Commission (SEC), issued on June 23, 2020, reminds listed companies about their disclosure obligations in light of changes and challenges brought by COVID-19. This latest guidance builds on an earlier advisory, issued March 25, and provides the Commission’s additional views regarding operations, liquidity and capital resources disclosures companies should consider with respect to business and market disruptions related to COVID-19.
In light of this most recent pronouncement we are republishing our advice to companies to re-evaluate their accounting, reporting and disclosures, as well as Internal Controls Over Financial Reporting (ICOFR) practices, with specific areas of focus highlighted.
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. 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.” Nevertheless, the vast majority of companies have already committed to and are forging ahead with the new model. See this Protiviti blog post for modeling considerations in the current environment.
- 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.
COVID-19 Impacts in Annual or Periodic Filings — 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.
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.
Ongoing news coverage of COVID-19 indicates that there is still uncertainty and volatility in the 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.