When organizations are financially struggling or affected by external events, several accounting considerations come into play. External events arising from the COVID-19 pandemic and its disruption could intersect with several components of accounting. A brief summary of possible considerations are described below.
Uncertainly is still a large factor in terms of how to move forward in light of new regulations, stimulus measures, operational changes, and ongoing changes as the operating environment stabilizes into a new normal. Being proactive with identifying how some of the accounting considerations may affect your organization can reduce some of that uncertainty as we move through the second half of the year.
Organizations must assess whether they have the resources to service their debt when preparing financial statements including interim or quarterly financial statements. Put another way, organizations evaluate whether they can continue as a going concern. A two-step evaluation process is key for businesses assessing going concern.
- Step 1: Do conditions and events, in the aggregate, result in a conclusion where substantial doubt that the entity will be able to continue as a going concern exists?
- Step 2: Are management’s plans to address the facts and circumstances probable of alleviating the substantial doubt?
During the evaluation process, consider how temporarily or indefinitely ceasing operations will account for liquidity. Your organization will have to consider if necessary capital or funding can be accessed as well as determine the declining value of existing assets or fluctuation in employee accessibility. For an in-depth look at how COVID-19 affects going concern evaluations, see our earlier article here.
Accounting for Impairment
Another factor that could be upset by the COVID-19 disruption involves the evaluation for asset impairment, which generally occurs when there has been a triggering event. In the wake of COVID-19 pandemic, organizations may find that long-lived assets are not be recoverable. It is important to analyze and test for impairment considering the larger economic impacts of the pandemic as well as how your business will have to change because of industry involvement and market considerations. Increases in cost due to raw material shortages or labor augmentation will factor heavily into how your organization operates as the market remains in a state of fluctuation and uncertainty. See a closer examination of impairment risk coming from the pandemic here.
Financial Statement Disclosures
The pandemic may produce a surplus of disclosure requirements for 2020 financial statements. Material change in terms of debt, stock compensation, leases, and supply will trigger disclosures. Impairment and triggering events for liquidity will also come with enhanced disclosures as will your organization’s use of estimates and the possibility of a material change in the near term. For example, if your organization was affected by a local shutdown order but expects the order to be lifted before year end, that could affect your use of estimates related to future financial performance.
Vulnerability from Concentrations
Concentrations of business volume, revenue, resources and geographic location will need to be monitored closely for disclosure under ASC Topic 275. These concentrations include the volume of business conducted with a particular customer, supplier, lender, grantor, or contributor, revenue concentrations from particular products, services, or fundraising events, availability of materials, labor, services or licenses, and the market or geographic area in which an entity conducts operations.
Public companies may have additional accounting issues to monitor throughout the pandemic, some of which the SEC highlighted in its Staff Topic No. 9 publication. Publicly traded companies will be mindful to refrain from trading prior to dissemination of material non-public information. Non-GAAP metrics related to the pandemic should be incremental and directly attributable to the pandemic. For example, public companies should not be adding hypothetical revenues or make adjustments for ongoing effects of the pandemic.
Significant changes may be need to be implement for entities that have adopted or developing plans for adoption of the new credit loss impairment rules. Current Expected Credit Loss (CECL) changes the timing of recognition of losses, which may result in changing internal controls to accurately account for credit losses. Under the Financial Accounting Standards Board’s Accounting Standards Update 2016-13, organizations should further calculate when losses should be recognized for assets measured at amortized cost. For entities using the new CECL model and those continuing to use the incurred loss model, a variety of historical information will need to be gathered to correctly determine how to measure credit losses.
The internal control process and guidance for inventory accounting can be significantly impacted by changes that occur during the current economic and regulatory climate. Control processes to evaluate, assess and reset standard inventory costs may need to be run more frequently to address fluctuating prices and additional costs introduced into manufacturing environments associated with additional protective supplies and changes to accommodate social distancing guidelines. When a manufacturer experiences shut-downs or reductions in capacity, it is necessary to consider the guidance on normal capacity and the direct expensing of excess fixed costs incurred due to the lower production levels.
Distribution challenges will likely include adjustments to address future supply demands when the situation normalizes, or to address the conditions continually fractured by disruptions in supply chains. Excess inventory or inventory with reduced selling prices will also have to be evaluated under the concepts of lower of cost or net realizable value (or market) keeping in mind that write-downs cannot be reversed in terms of establishing a new cost basis at the end of the reporting period.
Income Tax Accounting
Income tax changes brought on by the Coronavirus Aid, Relief, and Economic Security (CARES) Act may require reassessments of carrybacks, carryforwards, and other deductions that may impact the current and deferred tax provision. Both the current economic environment and the changes in the CARES Act may also have significant impacts on the assessment of the need for a valuation allowance. For companies preparing financial statements for interim periods, there may be additional challenges with estimating the full-year taxable income for ASC Topic 740 and the annual effective tax rate. For additional discussion of the impact the CARES Act has on income tax accounting, see our earlier article here.
A program that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity, or the manner in which that business is conducted, as defined by the International Accounting Standard No. 37 in 2002.
Accounting for Restructuring
Plans to restructure business activities or operations come with several types of accounting considerations, including the costs of disposing business activities, impairments of long-lived assets, and accounting for severance and other benefits provided to employees, such as incentives for continued employment during the operational wind down. SEC registrants may have additional disclosures related to these activities. For a more in-depth look at these different tax issues, see our earlier article here.
Modifications may have been made to contracts based on the pandemic disruption. Revenue recognition areas impacted by COVID-19 will concern probability of collection, variable consideration, and over-time measurement. Guidance provided under ASC Topic 606 outlines the steps necessary for your organization to evaluate revenue recognition internal control procedures. For a closer look at how revenue recognition will be affected, please see our earlier article.
Accounting for the PPP
If you received a Paycheck Protection Program (PPP) loan, note that there are varying accounting guidance options available depending on your unique circumstances. Which guidance or analogy for purposes of U.S. Generally Accepted Accounting Principles (U.S. GAAP) you use affects the threshold for recognition, timing of recognition, and income statement presentation for the amounts that are forgiven or expected to be forgiven.
For More Information
If you have specific comments, questions, or concerns about accounting for the impact of COVID-19, please contact Mark Winiarski of the MHM Professional Standards Group at firstname.lastname@example.org or by phone, 816.945.5614.
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