Global efforts to contain the spread of COVID-19, often referred to as the coronavirus, have significantly impacted many businesses and the global economy. While the situation is evolving rapidly, and the full impact is not yet known, the disruption caused by the coronavirus is affecting business and consumer activities worldwide–including disruption to major financial markets, supply chains, interruption of production, limited personnel, facility and store closures, and decreased demand from both business customers and consumers.
The disruption and uncertainty caused by the coronavirus is far-reaching. These events will result in unique accounting, disclosure, and internal control considerations that should be carefully evaluated by entities and their stakeholders.
The ultimate impact of the COVID-19 pandemic on an entity’s financial reporting will vary based on its unique business risks and circumstances. Below are some of the relevant GAAP requirements and disclosures that should be considered.
The substantial impact of the outbreak may require entities to include a subsequent event disclosure related to COVID-19. ASC Topic 855, Subsequent Events, provides guidance on the principles and requirements for subsequent events. Entities will need to carefully consider the nature of events that occurred before the issuance of the financial statements to determine whether that information needs to be disclosed or recognized in the financial statements.
Financial statements should recognize the effects of subsequent events that provide additional evidence relating to conditions that existed at the balance sheet date. Events that provide evidence relating to conditions that did not exist at the balance sheet date should not be recognized. Rather, entities should disclose the nature of a non-recognized subsequent event and an estimate of its financial impact, or a statement that such an estimate can’t be made, when the absence of such disclosure would result in misleading financial statements.
The effects of coronavirus are likely to be considered a non-recognized subsequent event in the calendar year end 2019 financial statements of most companies. The effects of government mandated restrictions on future revenues, losses in market value of investments, or other adverse conditions and uncertainties will frequently be of such significance that disclosure will be considered appropriate.
Risk and Uncertainties
ASC Topic 275, Risks and Uncertainties, requires entities to disclose information about risks and uncertainties that could significantly affect the amounts reported in the financial statements or the functioning of the reporting entity in the near term. Specifically, risks related to certain significant estimates and vulnerabilities due to concentrations must be evaluated.
The effects of COVID-19 may impact a variety of significant accounting estimates—for example, estimates related to volume discounts, variable consideration, or rebates in revenue contracts; financial projections utilized in asset impairment evaluations; or market data and other inputs used to value investments.
If information becomes known prior to the issuance of the financial statements that it is reasonably possible an estimate will change in the near term, and the effect of that change will be material, a description of the nature of the changed circumstances should be disclosed, including an estimate of the effect of the change.
Risks related to concentrations may also be magnified as a result of the pandemic. Vulnerability from concentrations arises because an entity is exposed to risk of loss greater than it would have had it mitigated its risk through diversification. For example, concentrations in the volume of business transacted with a particular customer or supplier could present risks to entities if those counterparties are adversely affected by COVID-19.
Entities are required to disclose risk related to concentrations in their financial statements if information becomes known that all of the following criteria are met:
- The concentration exists at the date of the financial statements.
- The concentration makes the entity vulnerable to the risk of a near-term severe impact.
- It’s at least reasonably possible that the events that could cause the severe impact will occur in the near term.
If the above criteria are met, entities should disclose information that’s adequate to inform users of the general nature of the risk associated with coronavirus, including:
- A description of what happened
- How the coronavirus outbreak has impacted operations
- How the coronavirus outbreak may impact future operations
ASC Subtopic 205-40, Presentation of Financial Statements–Going Concern, requires management to evaluate whether there’s substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued. This evaluation is based on events that are known and reasonably knowable at the date the financial statements are issued. Accordingly, entities will need to incorporate the effects of COVID-19 on their going concern evaluations prior to issuance.
Entities may need to reassess financial projections and other relevant information used in their going concern evaluation for the effects of the pandemic. Adverse factors such as reduced product demand, facility closures, and the ability to meet debt covenants or other key financial ratios should all be considered.
The impact of the coronavirus is wide ranging including disruption to supply chains, decreased demand from business customers, and decreased consumer spending. Financial projections and key assumptions adversely affected by COVID-19 could be indicators that and impairment has occurred.
GAAP’s asset impairment models vary based on the type of asset being evaluated.
ASC Topic 350, Intangibles–Goodwill and Other, requires entities to perform an impairment test of goodwill and indefinite-lived intangibles at least annually, or, more frequently if an event occurs or circumstances change that indicate it’s more likely than not that an impairment has occurred. Entities should carefully evaluate whether the effects of the pandemic trigger the need for an interim impairment test.
ASC Topic 360, Property, Plant, and Equipment, requires long-lived assets to be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The coronavirus outbreak may result in triggering events, such as changes in the planned use of an asset, that will necessitate more vigorous evaluations of the recoverability of machinery and equipment.
Similarly, significant investments in equity securities, debt securities, and equity method investments, should each be assessed for impairment in accordance with ASC Topic 320, Investments–Debt and Equity Securities or ASC Topic 321, Investments–Equity Securities and ASC Topic 323, Investments–Equity Method and Joint Ventures. Declines in the capital markets as a result of COVID-19 may increase the likelihood of impairments of these investments.
Disruptions to supply chains and decreased consumer demand may result in decreases to the net realizable value of inventories. Entities should assess whether the carrying value of their inventory needs to adjusted accordingly.
Additionally, the disruption to workforce availability and consumer demand as well as other unfavorable economic conditions may cause entities’ manufacturing production levels to drop below normal ranges. Fixed overhead costs are usually capitalized into the cost of inventory on a per unit basis, based on normal capacity and production levels. However, ASC Topic 330, Inventory, requires a portion of fixed overhead to be expensed, rather than capitalized into inventory, when production levels are below normal.
The coronavirus outbreak has the potential to impact both current and future revenue contracts. Under ASC Topic 606, Revenue from Contracts with Customers, revenue can only be recognized when it’s probable that the entity will collect substantially all of the consideration to which it’s entitled. If collection isn’t probable, entities will need to evaluate whether the arrangement qualifies as a revenue contract in accordance with ASC Topic 606. Similarly, as entities continue to sell products and provide services to customers impacted by COVID-19, they’ll need to carefully assess the customer’s ability to pay and whether write-offs of existing receivables are necessary.
Variable consideration is required to be estimated at contract inception and reassessed at each reporting date. Variable consideration can only be included in the transaction price to the extent its probable a significant revenue reversal won’t occur. The negative impacts of the pandemic on estimates of volume discounts, returns, rebates, and refunds or may require companies to update their previous estimates, including amounts that may be constrained.
Debt Modifications and Loan Covenants
As a result of the coronavirus outbreak, entities may need to amend the terms of existing debt agreements to gain access to additional liquidity. These amendments should be assessed under ASC Topic 470, Debt, to determine if the amendments represent a debt modification, debt extinguishment, or a troubled debt restructuring.
Under ASC Topic 815, Derivatives and Hedging, to apply hedge accounting, hedged forecasted transactions are required to be probable of occurring. Entities will need to assess the probability assertion of forecasted transaction as a result of the coronavirus outbreak. If the likelihood of the hedged forecasted transaction is no longer probable of occurring, hedge accounting may not be applied, and all future changes in the fair value of the derivative should be directly recognized in earnings.
Entities with operations in affected areas will also need to reevaluate their assertion of their intent and ability to indefinitely reinvest foreign earnings in accordance with ASC Topic 740, Taxes.
Stock compensation arrangements with performance conditions based on the achievement of future metrics may no longer be assessed as being probable due to the coronavirus outbreak and entities may need to consider modifying award targets. Contract modifications and costs incurred related to contract modification should be assessed under ASC Topic 718, Compensation–Stock Compensation.
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