Audit Issues Emerge Amid COVID-19 Fallout
The currently unforeseeable ramifications of COVID-19 has public company management teams and their auditors scrambling to fulfill SEC reporting requirements in this very foggy economic environment. Timely financial statement reporting is still expected, even though onsite access to files and staff may be restricted by government order.
As part of this process, management will be required to make difficult decisions and predictions not only about its Company, but also about its customers, vendors and capital sources. In practice, however, trying to predict the future in this environment is beyond challenging considering the lack of clarity on a myriad of issues — not the least of which is not knowing when, and to what degree the government-mandated shutdowns will be lifted, and how much more fiscal stimulus may be forthcoming.
On a positive note, it is generally understood that management’s assessments are based on conditions or situations that are known — or could have been known — at the time of evaluation. The key is to make reasonable and supported projections based on reliable underlying information. Be thorough, be transparent and be diligent about documenting. History tells us that the good faith assessments you now must make in this fog of uncertainty, will be mercilessly scrutinized by regulators and litigators when the fog lifts. As we all know, hindsight vision is 20/20.
Key decisions and assessments management will need to make include:
As company management tries to figure out what next week or next month may bring, first and foremost, they also must ask “Will we still be in business a year from now?
The Financial Accounting Standards Board (FASB) requires management to make a determination whether preparing the financial statements on a going concern basis is appropriate. If so, FASB’s standards require management to look out a reasonable period of time (generally 12 months) past the date when it last issued financial statements, and assess whether there is substantial doubt about its ability to continue as a going concern for that 12-month period.
If you are wondering what constitutes “substantial doubt,” FASB defines it from a management perspective as a “probable” threshold — which means “likely to occur.” No doubt it will be exceptionally difficult to determine what is “likely to occur” in the midst of a global pandemic and the worst financial disruption since the Great Depression.
Once there is a determination of substantial doubt in continuing as a going concern, the next step is for company management to provide plans to effectively mitigate those conditions and events.
Though every company’s management needs to address going concern, it would be incorrect to now conclude that most every company has “substantial doubt” and automatically must or should pull the going concern trigger. Yes, we’re all in this together, but some businesses are better able to weather this than others. Many will actually prosper.
Goodwill and Intangibles
Citing pre-COVID-19 figures from data provider Calcbench, the Wall Street Journal reported that “the recent wave of deal making had created a pile of goodwill.” For all public companies trading on U.S. markets, goodwill exceeded $5.5 trillion. “S&P 500 companies had $3.5 trillion worth of goodwill on their books at the end of September 2019– up 67% from 2013 which represented 9% of total S&P 500 assets and 42% of total equity.”
Companies are required to evaluate the value of goodwill on their financial statements yearly and record any impairments. Companies also are required to perform an impairment test 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.” This is commonly referred to as a triggering event.
In light of the financial effects of the COVID-19 pandemic, it is expected that more companies will need to test goodwill impairment between annual testing dates.
“For many entities, recoverability of goodwill balances has not been a heightened concern in recent years because of overall favorable economic conditions. Specifically, until recently, the market capitalization of many publicly reporting entities has been in excess of their carrying amounts as measured by net assets. Such excesses may no longer exist for some entities because of recent dramatic declines in equity markets,” according to Deloitte.
Accurately adjusting goodwill to its carrying value becomes especially important when a company faces insolvency because all goodwill value disappears, leaving less residual equity for shareholders.
Recoverability and Valuation of Recorded Assets
Management will need to develop predictive models of its cash flow and liquidity. In that process, they also will need to assess the economic effects on its customers and vendors.
Accounts receivables may represent valid and enforceable claims for past shipments or provision of services, but do those customers now have the ability to pay?
A few examples illustrate the challenge. Remember all that inventory you purchased at year end to take advantage of volume discounts? Will you still be able to sell it? Is it perishable with a limited self-life? Are your customers still in business? Fully operating?
Great! Your customers are somewhat intact and they still want your product. So, how are your suppliers doing? How long before the supply chain recovers?
And, if you’re still waiting delivery on that shipment from China, well… lots of luck!
Feds Add Billions More for Small Businesses and Health Care Providers
The President signed into law on April 24th a $484 Billion bipartisan bill that will recharge the SBA administered Paycheck Protection Program (PPP).
The original $349 billion provided under the $2-trillion CARES Act was quickly tapped dry. It now has another $300 billion that is intended for smaller business (generally under 500 employees) to maintain employees during the COVID-19 disruption.
The act also provides an additional $75 billion for reimbursements to hospitals and healthcare providers, and $25 billion for research and development of COVID-19 testing, of which $11 billion may be used by states and localities for employer testing.
The SBA concurrently clarified eligibility requirements: The loans are designed to support small businesses. “Hedge funds and private equity firms are primarily engaged in investment or speculation, and such businesses are therefore ineligible to receive a PPP loan,” the SBA wrote in an update.
Also noted, the “safe harbor” protection that allows entities that should not have received SBA funds to return the money without penalty expires May 7th.