As entities with June 30, 2020 year-end reporting dates prepare their financial statements for the first time post the COVID-19 pandemic, they will need to address the many potential financial reporting issues which have arisen as a result of the economic fallout of COVID-19.
The financial reporting implications of actions which entities have taken in response to COVID-19 are vast, with many having a significant impact on financial reporting. However, many of these impacts are as a direct result of actions which a company has taken, such as applying for a paycheck protection loan, restructuring or deferring debt or lease payments, or discontinuing some or all of certain operations. There are several financial reporting considerations that all entities will need to consider, irrespective of whether they have taken specific actions related to COVID-19.
Let’s review several of these now.
To defer or not to defer
With the issuance of ASU No. 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities, entities which have not yet issued a set of financial statements under ASC Topic 606 may defer that guidance’s effective date for one year. This standard was issued by the FASB in recognition of the challenges that many entities either have had or will have in completing their ASC 606 implementation.
While the obvious answer for such entities is to take advantage of the deferral, this may not be the best option. First, entities need to assess their available resources against the level of effort that will be required to report under ASC 606 for June 30, 2020. Clearly, if an entity does not have the resources to complete an effective transition to ASC 606, it should take advantage of the deferral.
However, many entities have already done a significant amount of work in preparing for ASC 606 implementation, even if they are not totally complete. By deferring the effective date of ASC 606, they may be potentially wasting this effort. For example, if an entity has chosen the modified retrospective adoption method, it may have already completed its determination of the cumulative effect adjustment required when adopting ASC 606 as of July 1, 2019. Additionally, it may have already been tracking the information which it needs for ASC 250 period of adoption disclosures. As such, deferring the effective date of ASC 606 would result in having to recompute this adjustment and disclosure information as of a later date.
Further, while the deferral provides more time for ASC 606 implementation, taking advantage of the deferral also pushes the incremental effort necessary to complete implementation into next year, when that time could be better spent on such actions as ASC Topic 842, Leases, implementation, implementation of other new accounting pronouncements, or toward other business recovery efforts. While the decision to defer or not should be based on the facts and circumstances of each individual entity, its important to consider both the short-term and long-term consequences of both deferring and not deferring the ASC 606 effective date when making this decision.
Does Substantial Doubt Exist?
While traditionally assessing whether substantial doubt exists about an entity’s ability to continue as a going concern has been an independent accountant’s concern, the issuance of ASU No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, places the burden of initially considering whether a going concern issue exists, along with developing related disclosures, clearly on the shoulders of the entity.
Clearly many entities are experiencing significant financial difficulty related to the COVID-19 caused financial shutdowns and related events and many companies are contemplating whether substantial doubt exists for the first time in the entity’s existence. When making these assessments, companies should realize that not all entities will have such substantial doubt, meaning that it is likely that they will not be able to meet their financial obligations as they become due in the look-forward period. While severe, the financial impact of COVID-19 is not equally felt by all entities. In some instances, companies have actually seen improved financial performance in this environment. The key consideration is that an entity must make this determination based on its individual facts and circumstances and it must follow through to the financial statement disclosure implications which its assessment leads them. As the AICPA has noted in several communications on this topic, there is no pre-determined outcome to this assessment of whether substantial doubt exists.
One last consideration on this topic. Irrespective of its conclusions on this topic, an entity should effectively communicate with its accountants on an ongoing basis on this assessment. First, it is key to keep the accountants informed of such a key financial reporting consideration. Second, as part of its reporting requirements, the accountants will also need to conclude on management’s assessment. A disagreement between management and its accountants on this topic could result in the qualification of the accountant’s audit opinion or review report, an outcome which neither party desires. Even if agreeing to disagree, the entity and its accountants need to have effective communication on this matter and have a full consideration of the implications of decisions reached, in all circumstances.
How Much Disclosure is Enough?
While much financial statement disclosure requirements are due to specific considerations, such as going concern, or events or transaction-based considerations, such as subsequent events or debt restructurings, other financial statement disclosures are required in any set of GAAP financial statements, such as those required related to accounting estimates and risks and uncertainties. Often these disclosures appear to be boilerplate and frequently do not change year to year in the financial statements. However, for June 30, 2020, such disclosures take on new relevance.
Under ASC 275, entities are required to disclose the risks and uncertainties that are relevant to the entity and that address the following:
- The nature of the entity’s operations, including the activities in which the entity is currently engaged if principal operations have not commenced.
- The use of estimates in the preparation of the entity’s financial statements.
- Significant concentrations in certain aspects of the entity’s operations.
These disclosures should be tailored to an entity’s specific facts and circumstances. As we have seen, many of the potential financial impacts of COVID-19 may not require recognition in an entity’s financial statements, or, if so, only after the occurrence of certain triggering events. However, that doesn’t mean that significant risk still doesn’t exist. As recent SEC disclosure guidance advises, clear and meaningful disclosure of material risks and uncertainties is key in allowing stakeholders to assess the impact of COVID-19 on an entity’s operations. This is probably more true when such impacts have not be recorded in the financial statements. It is vital that all entities review their current ASC 275 disclosures as part of their June 30, 2020 financial statement preparation process and make any necessary updates, even if it means going above and beyond the minimum disclosure requirements.
In summary, preparing financial statements at June 30, 2020 will be quite a challenge. Entities will need to consider the applicability of accounting guidance which they may not have considered as applying in the past. In addition, they will need to determine whether to adopt ASC 606 or not. Hopefully this post provides some additional thoughts for consideration which will assist you with financial reporting in this challenging environment.
Rich Daisley, CPA, is Vice President of Accounting and Financial Reporting Curriculum for Surgent CPE. With over 26 years of experience in the accounting and auditing field, Mr. Daisley has worked in both the client service setting, mainly for PwC’s Capital Markets and Accounting Advisory Services Group and for PECO Energy’s Merger and Acquisition Group, and in the internal capacity setting as a course developer and facilitator creating leading training courses for PwC and Surgent. Rich lives in suburban Philadelphia.