As coronavirus-related lockdown restrictions ease across the U.S. and businesses begin to reopen, additional data will become available that will provide a better sense of the true impacts of the virus on companies’ financial condition and performance.
In evaluating the data for potential impacts on key accounting and financial reporting areas, public company management and boards should keep in mind the guidance and warnings issued by the SEC, FASB, AICPA, and other regulators, which make clear that the potential accounting and reporting implications of the pandemic for public companies are extensive, affecting areas including disclosures, non-GAAP financial metrics, impairments, revenue recognition, and internal controls over financial reporting. These areas are ripe for future SEC investigations, as SEC Enforcement Co-Director Steven Peikin recently suggested, emphasizing in a keynote address that “pre-existing accounting or disclosure improprieties” are often exposed under the stress of an economic downturn.
Throughout the pandemic, the SEC has emphasized the need for registrants to provide transparent disclosures regarding Covid-19’s impact on their ongoing financial and operating conditions. When evaluating how to address disclosure obligations arising from the pandemic, companies and boards should consider the following areas:
- Management’s Discussion and Analysis: When preparing Forms 10-K and 10-Q, consider whether the pandemic’s impact has resulted in a material change in liquidity, financial condition, or results of operations, and if so, make necessary disclosures in the MD&A section of the filing as required by Item 303 of Regulation S-K. Importantly, management must assess whether there are “known trends and uncertainties” that require disclosure and should not forget the overarching goal that MD&A should allow investors to see companies “through the eyes of management.” This is an area that SEC’s Division of Enforcement focused on in response to the 2008 financial crisis.
- Risk Factors: Consider addressing coronavirus in risk factor disclosures, either as a new stand-alone risk factor or integrated into and expanding already existing risk factors. Such disclosures may include potential impacts on operations related to supply chain disruptions, employee quarantines, government measures, financial covenant compliance, availability of financing, and market volatility. Companies with strong operating ties to heavily impacted industries or geographic areas should particularly consider including appropriate risk factor disclosures.
- Forward-Looking Statements: Consider addressing coronavirus in the company’s cautionary language concerning forward-looking statements to provide the appropriate “meaningful cautionary” language needed to benefit from the safe harbor under the Private Securities Litigation Reform Act. In their joint statement on April 8, 2020, SEC Chair Jay Clayton and Director of the SEC’s Division of Corporation Finance, William Hinman, specifically stated that companies should avail themselves of the statutory safe harbors for forward-looking statements, noting that they “would not expect good faith attempts to provide appropriately framed forward-looking information to be second guessed by the SEC.”
Key Accounting Considerations
Public companies should also consider the following accounting areas when assessing the pandemic’s impact on their financial statements. Not surprisingly, the SEC focused its enforcement efforts on similar areas in response to the 2008 financial crisis, including asset impairment testing, accounting for loan and lease losses, and related internal controls over financial reporting.
- Non-GAAP Financial Measures: In light of the SEC’s request for enhanced coronavirus-related disclosures, many companies may consider using non-GAAP financial measures to highlight the effects of the pandemic and provide investors with views of more normalized results of operations. When evaluating whether and how to use non-GAAP financial measures in this regard, companies should consider the guidance from the Division of Corporation Finance, which is largely consistent with existing requirements under Item 10(e) of Regulation S-K.
- Credit Losses: The disruption caused by Covid-19 has placed pressure on issuers’ implementation of Accounting Standards Codification (ASC) 326, which governs accounting for credit losses, in two important ways. First, the virus has led to uncertainties in forecasting the collectability of debts as the global economic environment slows. While the rule does not require the use of any particular method to determine a company’s allowance for credit losses, accounting professionals are counseling conservative, valuation-based approaches to determine the creditworthiness of borrowers. Second, the CARES Act, signed into law on March 27, 2020, provides limited relief for certain insured depository institutions, bank holding companies, their affiliates, and credit unions regulated by the National Credit Union Administration. Under the law, covered entities may delay their implementation of ASC 326 until the earlier of Dec. 31, 2020, or the end of President Trump’s national emergency declared in connection with the virus.
- Revenue Recognition: Similar to credit losses, potential impediments to collectability due to the disruption caused by coronavirus may require registrants to reassess their receivables and related revenue recognition under ASC 606, even for customers that have a strong credit history. Additionally, variable consideration, such as agreed upon price concessions, discounts, or returns, may be constrained due to the pandemic’s disruption, thereby requiring a reduction in revenues.
- Asset Impairments: In its recent guidance, the SEC’s Division of Corporation Finance urged companies to consider whether Covid-19 might affect certain assets on their balance sheets and their ability to timely account for those assets. In particular, the guidance advised companies to evaluate whether they need to change any of the judgments that underlie their valuation of assets under GAAP or IFRS, and whether they should disclose material impairments to assets such as goodwill, intangibles, inventories, financing receivables, and investment securities. With respect to goodwill in particular, companies should carefully monitor the ongoing impact of Covid-19 on their business and consider whether that impact represents a triggering event. Examples of potential triggering events include a sustained decrease in share prices due to the resulting economic downturn, limitations on access to capital, cost increases, and changes in management and key personnel.
- Internal Controls: The Division of Corporation Finance’s guidance encourages companies to consider disclosing the extent to which coronavirus has put pressure on their internal controls over financial reporting (ICFR), raising the likely scenario in which remote work arrangements may present challenges in maintaining the controls in place under normal times. For example, companies should identify and modify manual controls, such as those that document review and approval through physical signatures and will not be feasible under remote working arrangements. Companies should also ensure that their controls around particularly subjective accounting areas, such as those referenced above, are tested and well-documented given the heightened scrutiny that these areas will likely receive.
Recognizing the ongoing challenges of meeting timing requirements in light of the pandemic, the SEC recently announced that public companies will have an additional 45 days to file certain reports, including Forms 10-K, 10-Q, and 20-F, that would have otherwise been due between March 1, 2020, and July 1, 2020. Companies taking advantage of such relief are required to file a Form 8-K that explains why the relief is needed for each delayed report and disclose the reason for the untimely filing in the delayed report once filed, among other conditions.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Mark Flinn is an associate, Jon Tuttle is a partner, and Jon DeMars is an associate at Debevoise in Washington.