20-3, COVID-19 and Financial Reporting Trends — Accounting for the Pandemic in the Current Quarter (June 5, 2020)

When events or changes in circumstances indicate that it is more likely than not that an asset is impaired, a company is required to test it for impairment even if the asset must also be tested annually for impairment (e.g., goodwill and indefinite-lived intangible assets). In the current reporting period, a company is expected to continue to contemplate the potential effects of COVID-19 on the impairment of its assets, which includes considering broad economic indicators as well as its specific facts and circumstances such as its industry, its geographic areas of operation, its “cushions” (excess of fair value over carrying amount), and the actions it has taken or expects to take in response to the pandemic. While companies must routinely use judgment when testing assets for impairment, their need to use such judgment is amplified given:

• The novelty of the pandemic and its impacts on business, consumer demand, and government actions (e.g., modeling the impacts of limitations related to travel, stay-at-home directives, the CARES Act).
• The impact of events and changes in circumstances that occur after the date used to test assets for impairment.
• Indications of value evidenced by market capitalization in periods of volatility.

Companies will need to assess their ability to realize DTAs before their expiration. Adjustments to forecasted income (like those assumed for other impairment analyses), including forecasted future losses, will need to be factored into that realizability assessment. Current and forecasted futures losses, particularly those that result in a cumulative loss or the expectation of a cumulative loss, may raise significant concerns regarding a company’s ability to use DTAs and, therefore, result in the recognition of a related valuation allowance. (See additional income taxes discussion.)

The potential prolonged disruption caused by COVID-19 may raise concerns about whether a company is able to continue as a going concern within one year after the date on which financial statements are issued. Companies will need to consider the following among other factors:

• Changes in forecast results.
• Potential liquidity and working capital shortfalls.
• Their ability to access capital.
• Contractual obligations.
• Diminished demand for products and services.

In the wake of COVID-19, many companies have made changes to various lease terms (e.g., timing of payments, amount of payments, duration of agreements). In addition, the FASB has provided relief related to the accounting for rent concessions resulting from the pandemic. Under such relief, instead of evaluating all concessions individually to determine whether they represent lease modifications, companies may choose to account for eligible concessions as lease modifications or apply various alternative models. The application of modification accounting to a large portfolio of leases can be particularly challenging because it involves the reallocation of consideration, the reassessment of lease classification, and the remeasurement of lease-related assets and liabilities. While the alternative models are expected to simplify the accounting analysis required for concessions, the selection of any one particular alternative model may result in amounts of lease expense and lease liabilities for lessees (and lease revenue and lease receivables for lessors) that differ from those applied under the lease modification framework and other acceptable alternatives models. As a result, companies must provide specific disclosures related to material concessions granted or received.

Some companies may seek to mitigate the effects of the pandemic by offering features such as price concessions, discounts on the purchase of future goods or services, free goods or services, extended payment terms, extensions of loyalty programs, opportunities to terminate agreements without penalty, or revisions to purchase commitments.

Under existing accounting guidance, gains or losses on a qualifying cash flow hedge of a forecasted transaction may be recorded outside of earnings as long as a company believes that it remains probable that the forecasted transaction will occur. While the guidance indicates that only in “rare cases”4 is it expected that hedging gains and losses would not be reclassified into earnings if it is still probable that a delayed forecasted transaction will occur more than two months after the original forecasted period, the FASB has indicated that the effects of COVID-19 qualify as a “rare case.”

An amount may be deemed uncollectible for several reasons, such as credit risk or adjustments in the transaction price (e.g., price concessions, rebates, discounts). While differentiating between credit risk and adjustments in the transaction price may not affect the overall outcome of the collectibility analysis (and thus the estimated value of accounts receivable), the presentation of such amounts could differ significantly (i.e., recording bad debt expense vs. reduction of revenue) along with the related disclosure requirements depending on the deemed underlying cause (e.g., credit risk vs. price concession) of the collectibility concern.

A lessor’s agreement to give a lessee a concession, regardless of its form, is not an automatic indicator that collection of lease payments from that lessee is no longer probable. Conversely, a lessee’s need for a concession, coupled with the economic downturn that many sectors are experiencing, may be relevant in the lessor’s collectibility assessment. In addition, if a lessee does not pay or only partially pays a lessor and that short pay is neither formally accepted as a concession nor allowable in the original agreement, it may be a negative indicator in the lessor’s collectibility assessment. (See additional leases and rent concessions discussions.)

Common measures that many companies have taken in response to the pandemic include implementing the terms of an existing termination plan, granting furloughs or temporary layoffs, offering one-time employee termination or relocation benefits, providing compensated absences, or a combination of these or different benefits and plans. Depending on the specific terms and conditions of such arrangements, costs and or liabilities may be incurred that span several reporting periods or present unique accounting challenges. The period in which expenses are reflected for financial reporting purposes may vary from one company to another, as well as within a company, depending on the types of plans and benefits offered. (See additional employee termination benefits discussion.)

Plans initiated by companies to address the pandemic may include facility closures, disposals of equipment, or sales of buildings. Since such plans may take the form of immediate disposition or continued partial operations until the time of disposal, they give rise to questions about the timing of when costs should be recognized, the amount of costs to be recognized, and the presentation of those costs, all of which depend on the specific facts and circumstances associated with the activity. (See additional exit or disposal costs discussion.)

Many aspects of the CARES Act present companies with a broad range of financial reporting challenges. Companies will need to determine the accounting guidance and policies to apply related to government assistance received as well as the appropriate timing for recognizing such government assistance (which may not correspond to the timing of cash received under the CARES Act), presentation, and disclosures. Also, companies should monitor subsequent clarifications to the various aspects of the CARES Act along with potential new government mandates or orders.

As a result of the pandemic, SEC registrants have made, and are likely to continue to make, changes to various footnotes within the financial statements as well as other parts of their SEC filings, including risk factors, MD&A, description of the business, disclosure controls and procedures, and internal control over financial reporting. Within MD&A, as well as in press releases and other forms of communication, companies may consider adjustments to their non-GAAP measures and other metrics.