May 13, 2020
Published: Accounting Today
By Clancy Fossum, CEO, Embark
The sky might not literally be falling, but it sure feels like it is. As the world grapples with the escalating impact of the coronavirus pandemic, a stark realization is now sweeping over accounting and finance teams — they’re the ones who have to figure out how countless uncertainties fit into their reporting and GAAP.
And to throw even more regulatory salt into the wound, they don’t have a lot of time to do it. Q1 closing is already underway, so besides treading in uncharted waters, financial leaders are also very much on the clock. But as teams roll up their sleeves to try to make sense of it all, they can save CFOs and CAOs many sleepless nights by keeping some key incremental requirements and considerations in mind.
Dealing with uncertainty in prospective cash flow estimates
Speaking of sleepless nights, inaccurate forecasting just might be every CFO’s worst nightmare. However, with so much uncertainty invading nearly every aspect of operations, a relatively routine exercise like a cash flow estimate has suddenly become a daunting task.
Obviously, impairment is going to be a significant factor, but certainly not the only one. Income tax valuation allowances, going concern assessments, and compliance with loan covenants, amongst others, will also be critical considerations.
As a best practice, many companies are running multiple cash flow scenarios, applying probability weighting to best, worst and middle-of-the-road assumptions to account for uncertainty in their analyses.
While this strategy is in no way ideal, it’s becoming more common as companies look for ways to balance accuracy and uncertainty while forecasting for an income approach to valuations. Companies opting for this route will likely need a valuation specialist for an independent assessment of a market approach, using it as a comparison against the income approach.
Heightened technical analysis requirements
Many companies — perhaps even most — will need to fine-tune their technical accounting skills. Once again, impairment of both nonfinancial and financial assets will be front and center indefinitely, so accounting teams should reacquaint themselves with the corresponding guidance if they need a refresher.
Likewise, now that Q1 is over for all calendar year-end companies, they’re moving into their 10-Q processes. Chances are, many businesses will find that COVID-19 qualifies as a triggering event under ASC 360 for several different analyses, including goodwill impairment and fixed asset impairment analysis. It’s safe to assume that any line items already on the watchlist will meet even greater scrutiny going forward, making technical accounting especially critical given what’s occurred in recent weeks.
Contract modifications and accounting implications
With so many businesses either forced to shut down or voluntarily downsizing out of employee and customer health concerns, contract modifications are another area in the financial reporting spotlight. Both companies and their customers are seeking relief through debt refinancing, lease amendments, customer contracts and compensation arrangements.
For example, the guidance on lease accounting, ASC 842, is quite specific for lessors and lessees under different scenarios, particularly in identifying and accounting for lease contract modifications and lease income recognition. Accounting teams unfamiliar with these nuanced yet essential differences can quickly find themselves overwhelmed, especially with rent concessions being so prevalent during this pandemic.
Companies with any business interruption policies should also take this opportunity to look through the policy’s fine print to see what it covers. Those that qualify for recoveries from lost profits or revenue should account for them under the GAAP gain contingency model in ASC 450-30.
Disclosure requirements or considerations
The onslaught of additional risk stemming from both internal and external variables will inevitably put disclosures under the regulators’ microscope. This includes a greater likelihood of subsequent event disclosures that aren’t necessarily in every SEC filer’s reporting wheelhouse. Companies will need to be more robust and specific when disclosing COVID-19’s impact rather than simply making blanket statements about things like loss contingencies as they relate to the pandemic.
Thankfully, the SEC has granted a 45-day extension for all regulatory filing deadlines through July 1, 2020. Any company that wishes to extend its deadlines must file a request stating that it’s seeking relief under the order, that the request is related to COVID-19 and include a risk factor disclosure with the request.
Internal control considerations
Finally, with so many companies experiencing a drastic change in their workforce — remote working, furloughs, layoffs or all of the above — there’s bound to be an impact on internal control over financial reporting and control environments in general. Naturally, all of these factors place additional importance on audit-specific concepts like the segregation of duties and availability of information.
Fast-forwarding a few months, many companies will likely run into issues from the first round of SOX testing. A company should be as proactive as possible in anticipating such issues, placing a priority on shoring up the control environment and mitigating the many new sources of risk, at least as best as their current resources and talent allow.
Like it or not, this is just the beginning of what will likely be a series of extremely trying quarters for many companies, on both the operational and regulatory fronts. However, keeping these points in mind will help finance leaders stay on the right side of the guidance while continuing to emphasize the health and safety of their employees.