The COVID-19 pandemic has disrupted nearly every aspect of operations for many businesses. As the pandemic continues, businesses face challenges regarding their relevant reporting requirements or other accounting issues.
Below, we provide an overview of 13 common accounting and reporting concerns impacting businesses during COVID-19 and actions your company could take to confront these issues.
Highlighted issues included the following:
1. Inventory Valuation
The pandemic could affect the recoverability of your inventory balances.
The following factors could indicate you have excess or obsolete inventory balances that aren’t recoverable:
- An increase in inventory balances in relation to sales levels
- A reduction in inventory turnover
- The aging of inventory
You’ll need to use judgment in determining what constitutes abnormal production levels in your business’ unique circumstances.
Declining prices could indicate the carrying amount of inventory is in excess of market value or net realizable value (NRV). The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 330 requires that most inventory be measured at the lower of its cost or:
- Market value for inventory measured by using last in, first out (LIFO) or the retail inventory method
- NRV for all other inventory
It’s important to determine if the utility of your inventory on hand has been impaired, and then apply the guidance in ASC 330-10-35-1A through 35-11. This guidance addresses adjustments of inventory balances to the lower of cost or market or NRV as appropriate.
Interim inventory impairment losses should generally be reflected in the interim period in which they occur, with subsequent recoveries recognized as gains in future interim periods of the same annual period.
Losses on Firm Commitments
In addition, losses on firm and unhedged commitments to purchase inventory or those that can’t be canceled should be measured the same way as inventory losses.
If material, they should be recognized in the accounts in the current period and separately disclosed in the income statement.
2. Recoverability of Receivables
Your company could also face a heightened risk of noncollection of receivables. Evidence of this risk might be noted by an increase in:
- Days sales outstanding
- Aging of receivables
- Amount of delinquent receivables
For loans receivable, evidence might include:
- Rising loan delinquency and defaults
- Decreasing secondary market liquidity
These situations can affect the risk of material misstatement in the valuation of your company's receivables and the sufficiency of management's estimate of the allowance.
Businesses should also evaluate receivables from customers in geographic regions most affected by COVID-19, even if those receivables aren’t yet past due.
You could incur additional write-offs of receivables deemed uncollectible or be required to establish additional reserves on receivables due from entities affected, or expected to be affected, by the impacts of COVID-19.
3. Recoverability and Impairment of Assets
As is the case with receivables, entities that have contract assets will need to evaluate recorded amounts for impairment in accordance with ASC 310 by assessing the customer’s ability to pay amounts when due.
The customer’s ability to pay could be adversely affected by the current economic instability.
Property, Plant, and Equipment (PP&E)
Your business should consider if the impact of the pandemic has caused:
- A decline in revenues
- An increase in costs or decline in net cash flows
- Both revenue decline and cost increases
Such changes could indicate that you should test your long-lived assets for recoverability.
Every company will be affected differently in terms of its cash flows and the susceptibility of its long-lived assets to impairment, so plan to document your considerations regarding recoverability.
Regardless of whether you recognize an impairment loss, you should still consider if the existence of a trigger indicates there’s been a change in the useful life or salvage value of your long-lived assets.
If a change is present, revise your depreciation or amortization estimates accordingly. Any revision to the remaining useful life of a long-lived asset should also be considered in developing estimates of future cash flows used to test the asset or asset group for recoverability.
Impairments to right-of use (ROU) assets could occur as a result of:
- Business closures
- Supply chain disruption
- Other consequences of the pandemic that negatively affect future cash flows derived from the use of the underlying PP&E
Intangible Assets Other Than Goodwill
Indefinite-lived intangible assets are tested annually for impairment and more frequently if an event or a change in circumstances indicates the intangible asset is impaired in accordance with ASC 350-30.
The macroeconomic slowdown from COVID-19 could initiate circumstances which indicate possible impairment of intangible assets.
In addition to evaluating the need for an interim impairment test, you should consider if there are any indicators an intangible asset classified as indefinite-lived has become finite-lived. This might occur if you change the expected use of the asset in response to the effects of the pandemic.
As a result of the pandemic, more businesses are expected to conclude they’re required to test the goodwill of one or more reporting units for impairment between annual testing dates.
Under US generally accepted accounting principles (GAAP), an entity is required to test between annual testing dates if an event occurs or circumstances change that would likely reduce the fair value of a reporting unit below its carrying amount.
4. Accounting for Financial Assets
Many debt and equity securities have experienced significant declines in fair value in response to the pandemic.
This could raise questions regarding if the duration of such declines will prove to be more than temporary.
5. Derivatives and Hedging
The pandemic could significantly affect both your:
- Ability to apply hedge accounting under ASC 815
- Earnings impact of hedge accounting
Volatility in markets caused by current events could cause your existing hedges to be ineffective. As a result, you might need to discontinue hedge accounting and make it difficult to assert that new hedges will be effective.
6. Revenue Contracts
As a result of business disruptions associated with the pandemic, you might be prevented from entering into customer agreements through your normal business practices.
This could present a challenge when determining whether or not you have enforceable rights and obligations.
In addition, many of your customers are likely experiencing financial difficulties and liquidity issues.
As a result, you may need to:
- Develop additional procedures to properly assess the collectability of your customer arrangements
- Consider changes in estimates related to variable consideration
Due to a business disruption, you may need to assess variables related to revenue including:
- Price concessions
To mitigate any decline in sales, you could offer customers sales incentives, including discounts on future goods or services.
Such incentives on the purchase of future goods or services should be assessed to determine if they represent:
- Material rights
- Discounts that are recognized in the future upon redemption
In addition, for new contracts, you may need to update your estimate of the stand-alone selling price of a material right if you extend the periods for use or provided additional incentives to a customer.
You may also need to reassess your breakage assumptions because of extensions or changes in expected usage patterns.
For example, modifying a loyalty program by extending your customers’ ability to use points could require you to reassess the breakage assumptions used.
Significant Financing Component
To assist customers experiencing liquidity issues in purchasing goods and services, you could provide extended payment terms.
Similarly, if facing your own liquidity issues, you could require customers to make an up-front payment in order to fulfill your promised goods or services.
In those circumstances, you should evaluate whether or not a significant financing component exists.
Implied Performance Obligations
During these challenging times, you might consider providing customers free goods or services that aren’t explicitly promised in the contract.
In these situations, you should determine whether or not your contracts contain:
- Promised goods or services that are implied by your customary business practices
- Published policies
- Specific statements that create a reasonable expectation that you’ll transfer those goods or services
Due to potential supply disruptions or other circumstances, you may need to reconsider the timing of revenue recognition if you’re unable to satisfy your performance obligations on a timely basis.
In addition, you’ll need to determine if there are any contractual penalties that would affect the transaction price. In some cases, you could be completely unable to satisfy your performance obligation.
This could result in:
- Termination of the contract
- Reversal of any revenue previously recognized for a performance obligation that wasn’t fully satisfied
- Recognition of a refund liability, or additional liability due to a payment of penalties, instead of deferred revenue
You could also incur unexpected costs in fulfilling a performance obligation that’s satisfied over time. Therefore, you may need to reevaluate the expected costs to complete your contracts and consider future material, labor, and the allocation of overhead rates.
If you have construction and production-type contracts, you may also need to consider if a change in your estimated costs would result in a contract loss that needs to be recognized immediately.
Your disclosures could also be impacted by the pandemic.
Impacts on disclosures could include but aren’t limited to:
- Disclosures of significant changes in the contract asset due to an impairment
- Significant payment terms, including any significant financing component
- Timing of when you expect to recognize revenue for remaining performance obligations
Given the level of uncertainty caused by the pandemic, it could be challenging to make certain critical estimates. Therefore, it’s important to disclose any significant judgments you made in accounting for your revenue contracts.
7. Exit or Disposal Costs
Market events and their effect on liquidity have caused many companies to take actions such as restructuring to reduce costs.
The risks of material misstatement could relate to recording costs in the improper period, incorrect measurement or presentation of restructuring liabilities and costs, or inadequate disclosures.
Misstatements could result in understatement or overstatement of restructuring liabilities and costs.
8. Contingencies and Guarantees
Recent events in the credit markets could expose companies to additional contingencies and guarantees. This, in turn, could increase the risk of unidentified or undisclosed contingencies.
Economic instability resulting from COVID-19 could cause you to incur losses that should be recognized, disclosed, or both.
Given the general uncertainty associated with the pandemic, you may find it challenging to develop estimates for loss contingencies.
9. Estimates and Assumptions for Stock-Based Compensation
Current market conditions have resulted in volatile stock prices for many companies. As a result, some companies might consider modifying share-based payment awards.
In addition, the changing economic environment could affect the assumptions used when valuing such awards. Modifications of share-based payment awards might result in the recognition of incremental compensation cost.
Some businesses might cease operations or operate at reduced capacity, which could affect the probability that performance targets for share-based payments with performance conditions are met.
If you have an accounting policy to estimate forfeitures associated with service conditions, you should consider the impact of such business decisions on estimated forfeitures.
10. Subsequent Events
Given the economic environment and likelihood of events occurring rapidly or unexpectedly, you should carefully evaluate information that becomes available after the balance sheet date but before the issuance of the financial statements.
11. Going Concern
Some companies could face challenges in their ability to continue operating as a going concern.
For instance, sources of liquidity might be strained because of the following factors:
- Reduced availability of lines or letters of credit from financial institutions
- A violation of a debt or other covenant
If you have substantial doubt about your company's ability to continue as a going concern for a reasonable period of time, you should document management’s plan to mitigate the effect of such conditions or events. Then, prepare to assess the likelihood that such plans can be effectively implemented.
The pandemic could give rise to specific transactions or events that change a reporting entity’s governance rights over other legal entities, thereby affecting accounting conclusions for consolidation.
13. Accounting for Government Assistance
In response to the pandemic, domestic and international governments are considering, or have implemented, legislation to help entities that have experienced financial difficulty.
Given the lack of guidance in US GAAP on the accounting for and disclosure of government grants, it’s critical to disclose your accounting policy for government grants if the grant amounts are material to your financial statements.
Furthermore, you’ll need to carefully evaluate your eligibility to receive government assistance, and your compliance with such assistance, before treating it as part of management’s plans to alleviate substantial doubt in a going-concern analysis.
We’re Here to Help
To learn more about how COVID-19 has impacted accounting functions or for outsourced help to meet your business’ accounting needs, contact your Moss Adams professional.
Note on COVID-19
During this unparalleled time, we’re closely monitoring the COVID-19 situation as it evolves so we can provide up-to-date guidance and support to help you combat uncertainty. For regulatory updates, strategies to help cope with subsequent risk, and possible steps to bolster your workforce and organization, please see the following resources: