Public companies were impacted by COVID-19 in various ways, whether simply by fluctuations in market capitalization or more systemic, operational disruptions. In Q1 2020, many public companies’ financial filings had limited quantifiable financial information related to the COVID-19 impact. While there is still a great deal of uncertainty as we near the end of Q2, investors are more likely to be expecting greater clarity in registrants’ Q2 filings, including a clear assessment of past, current, and future impacts of COVID-19 on accounting matters via related disclosures. For public companies preparing Q2 financial reports, the following are matters to consider prior to issuance.
Before bearing in mind Securities and Exchange Commission (SEC) requirements related to reporting and disclosures, public companies should thoroughly assess COVID-19 related circumstances, which may include:
- Significant operational disruptions, including remote work arrangements, adverse changes to financial reporting systems and adaptations to internal control procedures;
- Material COVID-19-related contingencies;
- Material impacts to the sources or uses of cash;
- Material uncertainty about the company’s ability to debt covenants, as well as the options available to remedy the material liquidity deficiency;
- Changes to the cost of or access to capital and funding source;
- Material increases in expenses, including increases in allowances for credit losses and restructuring charges; and
- Material changes in accounting judgments.
This comprehensive assessment should illuminate the areas of increased risk, for which additional analysis and/or reporting may be required.
Impairment and Recoverability of Assets
Due to increased volatility and stock price declines, most public companies will need to assess whether the circumstances represent triggering events. Even changes in the expected timing of cash flows may be a circumstance indicating that the carrying amount of an asset should be assessed for recoverability. Under these circumstances, it is important for management to consider the sequence in which assets are tested, and not simply jump to intangible asset impairment. The value of certain tangible assets, such as inventory, should be validated before those values are included in and confound the results of more comprehensive impairment analyses, such as goodwill.
Generally, assets that are not held for sale should be tested for impairment in the following order:
- Assets outside of the scope of ASC 360-10 (other than goodwill) such as inventory, capitalized costs to obtain or fulfill a revenue contract, investments and indefinite-lived intangible assets;
- Long-lived assets in accordance with ASC 360-10; and
- Goodwill in accordance with ASC 350-20.
While impairment analyses are already tedious and complicated, public companies frequently face additional challenges in performing impairment analyses, which often requires significant time and external resources. Impairment analysis for public companies are becoming increasingly complex, especially under COVID-19 circumstances, due to:
- Multiple reporting units, which leads to larger, more complex analyses;
- Developing bottom-up operational forecasts for each reporting unit, under several recovery scenarios;
- Accessing and compiling information from the plethora of data sources to support key inputs and assumptions;
- Ensuring consistency of assumptions between different reporting units, as well as from a consolidated perspective; and
- Reconciliation of the market capitalization to the concluded equity value, especially under periods of elevated volatility.
Management also must consider the effects of COVID-19 in performing assessments regarding a company’s ability to continue as a going concern under ASC 205-40, which requires management to evaluate “whether relevant conditions and events, considered in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued.” If conditions are identified which give rise to substantial doubt to continue as a going concern, management should carefully evaluate disclosure requirements. Remember that even when management has developed plans to alleviate these conditions, such as obtaining additional financing or implementing cost-saving measures, there are related disclosure requirements.
SEC Reporting and Disclosure Requirements
Outside of clear reporting requirements, such as those for impairment charges, public companies need to determine whether any other matters identified in the internal assessment phase rise to the level of a reporting obligation. In general, there is no broad 8-K disclosure obligation triggered by COVID-19. However, if companies take actions outside the ordinary course of business in response to the impact of COVID-19, those companies should confer with Items 2.03 through 2.06 in Form 8-K in order to deem those circumstances triggering or reportable events. Failing to do so may place corporate insiders at risk of trading on non-public, material information, an area under heightened scrutiny by the SEC. Accordingly, the SEC advises that if "a company has become aware of a risk related to the coronavirus that would be material to its investors, it should refrain from engaging in securities transactions with the public" and should "take steps to prevent directors and officers (and other corporate insiders who are aware of these matters) from initiating such transactions until investors have been appropriately informed about the risk."
In addition to 8-K disclosure items, which may include COVID-19 related reporting obligations, registrants may also file current management discussion and analysis (MD&A) reports on Form 8-K. While these MD&A disclosures are typically included in a Form 10-K or Form 10-Q, the rapidly evolving impact of COVID-19 spurred regulators to allow public companies to update investors in Form 8-K on the current and potential future impact of COVID-19 on the business. However, disclosures offering forward looking guidance should be carefully considered, given the assumptions made about future events. Companies providing such information about material developments caused by COVID-19 should contemplate the safe harbors guidance in Section 27A of the Securities Act and Section 21E of the Exchange Act in order to reduce their exposure.
Weaver’s audit professionals can provide guidance regarding Q2 financial reports in order to avoid some of the common pitfalls. Additionally, our valuation team can help create sensitivities, develop impairment reports, and defend the impairment analysis against the audit team’s experts, which becomes increasingly valuable when the triggering event is temporary in nature.
For more information, contact us. We are here to help.
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