How the coronavirus may affect financial reporting
The COVID-19 pandemic has thrown the accounting profession into a new realm of standards, laws and best practices, along with entirely new ways of doing business and working with clients. Like other industries, financial professionals are dealing with a tremendous amount of uncertainty, and that uncertainty is what makes it difficult to navigate the coronavirus financial impact and its effects on financial reporting.
“Financial statements aren’t a precise science,” says Timothy Gearty, Becker’s national lead instructor. “They require a tremendous amount of management judgment, and that management judgment is predicated upon the ability to forecast the economy.”
All told, CPAs are finding themselves navigating a range of issues around coronavirus and financial reporting.
The 5 biggest coronavirus financial impacts
1. CECL (Currently Expected Credit Loss). A standard implemented in December 2019 for public companies required to file with the SEC (and to be implemented in December 2020 for all other organizations), CECL no longer allows companies to make forecasts using historical debt trends. If 3% of your customers haven’t paid historically, for example, you can no longer presume that 3% will continue to do so going forward. CECL requires the use of reasonable and supportable forecasts about the future.
But as Gearty points out, the COVID-19 financial impact complicates making those kinds of forecasts. Determining how the long-term employment picture could impact customer demand, for example, can make it more difficult to project how a company can collect on its financial instruments, such as receivables, bond payables, and so forth.
2. Rent concessions. This is one of the most visible COVID-19 financial impacts. Landlords are concerned about losing tenants as companies downsize their real estate needs (either because of an increase in remote work or due to a reduced workforce) or go out of business altogether. At the same time, many tenants — who are struggling to pay rent — are seeking rent concessions from their lessors, in the form of one-off rent reductions, rent waivers or deferrals of lease payments. In the context of COVID-19 financial reporting, the question is how to account for such concessions. Is it a lease modification that requires the lessee to recalculate its lease assets and liabilities? Or should it be considered a variable lease payment?
3. Variable consideration in revenue recognition. Another instance of the uncertain nature of the coronavirus financial impact. Variable consideration includes discounts, rebates, refunds, credits, performance bonuses, penalties and similar items. If a contract includes variable consideration, then the company estimates the amount of consideration to which it will be entitled. In the current environment, however, Gearty points out that companies need to consider whether actions taken to respond to the pandemic impact the estimated amount of variable consideration. But COVID-19 has made these estimates more difficult to calculate. A company may have expected to receive a bonus for completing a project by a certain date, for example, but the pandemic adversely affected its ability to meet that deadline. How do you estimate that variable consideration?
4. The Payroll Protection Program. A more direct consequence of coronavirus and financial reporting is how to account for receiving funds as part of the PPP federal stimulus program. Should you follow the conventional wisdom of treating it as a debt and if qualified for forgiveness, than record “other income”? Or, if you expect the loan to be forgiven, should you comply with International Accounting Standard (IAS) 20 and treat it as a government grant? “We’re all scratching our heads about which of those two will be the preferred method,” Gearty says.
5. Assessing whether you’re a going concern. This is one of the more complex issues regarding the coronavirus financial impact. Companies will need to evaluate whether the economic downturn from the COVID-19 pandemic has affected their ability to continue as a going concern. That also requires mitigating the conditions that could put the organization at risk. “I would start by looking at adverse conditions,” Gearty says. “Management must make an assessment each reporting period whether they qualify to use full accrual accounting. And to qualify for full accrual you have to be a going concern. To make that assessment, you look at all the negative events and assess in their totality if there is a problem.”
Gearty says this assessment can include the following factors.
Negative financial trends, including:
- Recurring operating losses
- Capital deficiencies
- Negative cash flows
- Adverse key financial ratios
Other indicators of financial difficulties, including:
- Defaulting on loans
- Being in arrears on dividends
- Having usual trade credit denied
- Restructuring debt to avoid default
- Noncompliance on capital requirements
- The need to seek new sources of financing
Internal matters, including:
- Work stoppages
- Substantial dependency on a new product for the organization’s survival
- Uneconomic long-term commitments
- The need to completely revise your operational structure
External matters, including:
- Legal proceedings
- Loss of key franchises
- Loss of key patents
- Loss of key customers
- Uninsured losses
Factoring risk Into COVID-19 financial reporting
As Gearty points out, COVID-19 risk may impact your ability to assess asset impairment because of the difficulty in making reasonable cash flow forecasts. It could also impact your ability to determine liquidity, your ability to determine amount of restructuring costs going forward, and your revenue stream
Gearty notes that CPAs will also have to provide more thorough information in their financial statement footnotes. “The SEC has clearly stated that it does not expect to see boilerplate footnotes. They want to see a real analysis that’s unique to your company in the footnotes as well as the management discussion and analysis (MD&A) section.” This could include:
- Operational adjustments
- Changes in leadership
- Amendments to your financial arrangements
- The financial impact of the CARES Act
- Early warning disclosures regarding asset impairment
- An inability to meet debt covenants
- Expected employee termination and restructuring charges
“Give the reader insight into known trends and uncertainties,” Gearty says. “Of course, right now it’s hard to determine the trends, but we sure know about the uncertainties.”
Financial professionals will be coming to terms with the coronavirus financial impact for the foreseeable future. Gearty covers these issues in greater detail in his CPE course on coronavirus financial reporting challenges.