Source: RSM US LLP. PBMares is a member of RSM US Alliance.
The effects of the coronavirus are evolving rapidly and are unique for each entity’s circumstances. In addition to addressing the serious operational impacts of the coronavirus, it is important that all entities consider how the coronavirus affects their financial reporting. We offer the following high-level overview of a few matters for consideration during this critical time.
Financial statements need to reflect all material current and potential effects of the coronavirus that existed at the period end date. The significant deterioration in economic conditions associated with the coronavirus is generally viewed to have begun in the first quarter of 2020. Therefore, for calendar-year-end entities that have not yet finalized their 2019 financial statements, consideration should be given to disclosure of subsequent events in accordance with Topic 855, “Subsequent Events,” of the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC).
Valuation and impairment
For 2020 financial statements, consideration should be given to how the coronavirus potentially affects many estimates and related disclosures, including, among others, those related to valuation and impairment of:
- Receivables, loans and investments –The accounting for the impairment or recognition of credit losses on receivables, loans and investments is dependent upon a number of factors, including the instrument’s legal form, its classification under applicable accounting principles, and the reporting entity’s adoption date for recent guidance.
- ASC 310-10-35 is the primary guidance to consider in recognizing impairment and an allowance for expected credit losses on loans, off-balance sheet commitments and other receivables prior to the adoption of FASB Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Operating lease receivables are subject to evaluation under Topic 842, “Leases.”
- ASC 320-10-35 is the relevant guidance to consider when recognizing impairment or expected credit losses on debt securities prior to the adoption of ASU 2016-13, and was the relevant guidance to consider when recognizing impairment on equity securities prior to the adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.
- Upon the adoption of ASU 2016-01, equity securities that are not subsequently measured at fair value through earnings are written down to fair value in accordance with ASC 321-10-35-3 if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than its carrying value.
- ASC 323-10-35-31 to 35-32A, which applies to investments accounted for under the equity method and joint ventures, requires loss recognition for losses in value that are other than temporary.
- ASC 326, “Financial Instruments – Credit Losses,” is the relevant guidance to consider for available-for-sale debt securities, most financial assets carried at amortized cost and related off-balance sheet commitments upon the adoption of ASU 2016-13.
Relevant factors such as recent business disruptions, economic conditions and significant declines in investment valuations should be given careful consideration when performing the analysis required for the specific type of financial asset.
- Fair value – ASC 820, “Fair Value Measurement,” indicates the objective of a fair value measurement is to determine the price at which an orderly transaction would take place between market participants under the market conditions that existed at the measurement date. While the effects of the coronavirus are causing market volatility, it would not be appropriate to disregard market prices at the measurement date, unless those prices are from transactions that are not orderly.
- Inventories – ASC 330-10-35 addresses the subsequent measurement of inventory and requires losses to be recognized when the net realizable value of the inventory, or in some cases, the utility of the goods, is less than cost. The standard also requires losses to be recognized in a similar manner on firm purchase commitments related to goods for inventory. Reduced demand for oil that is attributable to the coronavirus and the resultant significant declines in oil prices is just one example of a type of inventory for which loss recognition may be warranted.
- Goodwill – Repercussions of the coronavirus could affect estimates of future cash flows and earnings, thereby materially affecting the measurement of fair value of a reporting unit and resulting in the need to perform an interim impairment test of goodwill. ASC 350-20-35-30 states, “Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.” Even private companies that have elected to amortize goodwill on a straight-line basis are required to test for impairment when a triggering event occurs indicating the fair value of the entity (or reporting unit) may be below its carrying amount.
- Other long-lived assets – ASC 360-10-35-21 states, “A long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.” The standard lists examples of such events or changes in circumstances, including a significant decrease in the market price of a long-lived asset and a significant adverse change in the business climate that could affect the value.
- Valuation allowance on deferred tax assets – Management may have to reconsider whether deferred tax assets are fully realizable, particularly if the entity has net operating loss carryforwards expiring in the near term.
Debt Agreements and Covenants
If the impact of the coronavirus causes disruptions that result in cash flow problems, entities may need to amend terms of existing debt agreements or obtain waivers for debt covenants. Thus, debtors may need to determine whether changes to existing debt arrangements represent a modification or extinguishment subject to the accounting requirements of ASC 470-50 or a troubled debt restructuring subject to the accounting requirements of ASC 470-60. Similarly, creditors that are making modifications will need to give consideration to ASC 310-40 in determining whether the modification is a troubled debt restructuring. If there has been a covenant violation or other default at the balance sheet date, debtors also should consider whether the classification of long-term debt needs to be revised in accordance with ASC 470-10-45.
Factors such as reduced sales and supply chain and other disruptions associated with the coronavirus also could impact the continued application of hedge accounting. When hedging forecasted transactions such as sales or purchases, ASC 815-30-40 requires hedge accounting to be discontinued if any criteria to apply hedge accounting are no longer met, including the criterion in ASC 815-20-25-15(b) that requires hedged forecasted transactions to be probable of occurring. Additionally, when the determination is made that it is probable that a hedged transaction will not occur within the originally documented time period (or the two-month period thereafter), amounts reported in accumulated other comprehensive income related to the hedging derivative must be immediately reclassified to earnings.
Going Concern, Risks and Uncertainties
If conditions or events related to the coronavirus raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued (or available to be issued), certain financial statement disclosures are required under ASC 205-40. Additionally, ASC 275 requires disclosures about risks and uncertainties including certain changes in estimates and vulnerability to concentrations. In certain cases, the circumstances related to the impacts of coronavirus on the entity’s operations, financial situation, or risks and uncertainties may warrant an emphasis-of-matter paragraph in the auditor’s report.
SEC Reporting Considerations
The SEC has reminded companies to provide investors with insights regarding their assessment of, and plans for addressing, material risks to their business resulting from the coronavirus. In addition to financial statement disclosures, specific risks may need to be disclosed in an SEC filing as risk factors. Also, among other required disclosures in management’s discussion and analysis of financial condition and results of operations, a registrant should describe any known trends or uncertainties that have had, or that the registrant reasonably expects will have, a material favorable or unfavorable impact on revenues or income. A company may need to update previous disclosures to the extent that information becomes materially inaccurate.
As previously announced, the SEC has provided conditional regulatory relief, which, subject to certain conditions, allows publicly traded companies an additional 45 days to file certain disclosure reports, such as Exchange Act annual and quarterly reports, that would have been due between March 1 and April 30, 2020.
This article was written by RSM and originally appeared on March 17, 2020.
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