Accountants: good luck putting a bow on 2020.
Companies in the thick of finishing their year-end financial reports have all the typical challenges of capturing the ups and downs of any year. But 2020 wasn’t normal. Then layer on an extra headache: providing insight to what could lie ahead when so much remains uncertain.
The unknowns touch almost all aspects of a company’s annual financial statement, from the discussion of risks to estimating the value of assets and customer contracts. Companies in sectors hit hard by the ongoing pandemic will have to make sensitive, fraught assessments about the viability of their business and whether they can survive as going concerns. Auditors, on alert for a management team’s tendency to paint rosy pictures, must watch for fraud and control risks.
“There’s fundamental uncertainty in the market, which now accountants, controllers, and auditors have to find a way to certify coming up to year end,” said Conor O’Kelly, senior director, statutory accounting at Workiva Inc.
Company executives are candid about how much they don’t know. Netflix Inc. CFO Spencer Neumann on the company’s fourth-quarter earnings call Jan. 19 told investors the company wouldn’t give full-year earnings guidance. “There is so much uncertainty in the business. We can provide a number but I’m not sure it’d be that bankable,” Neumann said.
Southwest Airlines Co. CEO Gary Kelly deflected a question about when the airline would return to profitability.
“it’s just an uncertain time like none of us have ever seen in our lives and anybody that tries to give you a real specific answer to those kinds of questions, they’re just they’re not telling you the truth,” Kelly said Jan. 28. “And that’s—that’s the God’s honest truth.”
Public companies with calendar year-ends have made it through three quarterly financial cycles since last March, so they know how to compile financial statements under pressure. But the audited year-end report carries more weight, is scrutinized more closely, and is longer than quarterly reports. Detailed footnote information for some financial accounting requirements, for instance, only kick in on an annual basis as opposed to every quarter, said Bruce Pounder, founder of GAAP Lab, an accounting consulting firm.
“There’s a very real sense that it is more important to get it right than at other times,” Pounder said. “That matters because there’s a lot more effort involved.”
Estimates and valuations become more complex in an unusual environment. Take an airline valuing a plane on its balance sheet. In a typical year, the carrier could estimate the plane’s value at $250 million, based on having a 10-year economic life carrying thousands of passengers with thousands of takeoffs and landings.
“Now that’s completely up for grabs,” said O’Kelly of Workiva. “We don’t know when travel restrictions are going to be lifted. You can’t really estimate the payload or passenger carrying capacity over the next nine months. Now you’re going to have to look at the useful economic life based on the public’s willingness to travel or appetite to travel.”
Assumptions about the fair value of assets and questions about the value of goodwill—the intangible asset that gets reported when a company buys another—becomes more complicated. Revenue, the top line in a company’s income statement, is affected if there are customer contracts that involve what’s called variable consideration, or payments that can fluctuate. If a company reduces its real estate footprint to save money on office space rentals, that could trigger lease accounting requirements.
“You literally have to do more accounting work in response to more things happening at the same time, and on a scale you probably never anticipated,” Pounder said.
Remote workforces, distracted employees, and pressures to stay afloat all create challenges. Audit leaders warned this month of a growing concern of fraud, citing the potential for improper revenue recognition, inventory misstatement, and incorrect impairment calculations as top concerns.
“The challenge is you’re operating not at the client site, operating remotely, and training and education of a client is challenging,” said Bill Eisig, national assurance managing partner at BDO USA LLP. “Yet the regulators remind us multiple times that the auditing standards don’t change just because the environment changes. The expectation from the regulators is the same.”
The Securities and Exchange Commission has issued several warnings that companies need to be transparent about the challenges they face around coronavirus and communicate any uncertainties to investors and analysts. The regulator in December announced it settled charges with Cheesecake Factory Inc. over the company’s “materially false and misleading” statements and the restaurant chain’s failure to disclose the financial impact of the pandemic. The agency said it was its first charge against a public company for misleading investors about the pandemic’s impact.
Companies will have to have these warnings on their minds when they file their year-end reports, as will auditors. For companies in industries where profits shrank because of stay-at-home orders, auditors will have to pay extra scrutiny to what the businesses report.
“In areas like retail or restaurants or energy, or certain other areas that have maybe more uncertainty, you certainly are even more cautious than ever in terms of accepting certain things from clients,” Eisig said.