20-5, COVID-19 Financial Reporting Trends — Different News or More of the Same? (September 11, 2020)

Companies continue to face challenges related to forecasting as a result of the ongoing uncertainties associated with the COVID-19 pandemic. Looking across the economic landscape, one might observe a tale of two markets: companies that are being challenged to get back to pre-outbreak operations and those that are benefiting from the outbreak.

Transparency! When it comes to disclosure and communication, we have all heard about the importance of transparency. And in the current COVID-19 environment, the need for transparent communication is magnified.

Internal control environments continue to become increasingly complex as companies navigate the impacts of COVID-19. While some aspects of such environments may have changed during the COVID-19 pandemic, the requirement for effective internal controls over financial reporting (ICFR) under the Sarbanes-Oxley Act has not changed, and regulators continue to focus attention on, and emphasize the importance of, such controls. Accordingly, companies should not lose sight of what is appropriate for effective ICFR versus what may be considered “normal” or “common” practices for dealing with the challenges of the COVID-19 pandemic, if such practices are not effective.

In recent months, we have seen an increased level of activity related to stock compensation plans and awards. The ongoing impact of COVID-19 has led to the obsolescence of many previously established company-specific performance targets. While some companies have modified awards to revise performance targets, others have delayed the timing of granting awards, issued “off-cycle” grants, modified the strike price of existing underwater options, and extended the exercise period for awards, all presumably in an effort to ensure that stock compensation arrangements continue to provide the intended motivation for company employees and executives to work toward accomplishing company goals and objectives.

In connection with optimizing their real estate footprint on a go-forward basis, a number of companies are reevaluating their leases or lease portfolios. From an accounting standpoint, companies should consider whether a decision to no longer use a leased asset constitutes an abandonment of the asset. Accounting guidance generally requires a company to accelerate expense recognition for assets deemed “abandoned.” However, to be deemed abandoned, a company needs to assess whether it has the ability and would be willing to sublease the leased asset at any point during the remaining lease term. This may include considering the economic environment and the expected demand in the sublease market and will likely require a company to use more judgment when assessing longer remaining lease terms. The potential that a company would be willing to sublease an asset at any point in the future may preclude the company from considering an asset to be abandoned and thus preclude the acceleration of expense recognition.

With the anticipated transition away from the use of the London Interbank Offered Rate (LIBOR) and certain other reference rates, the FASB has provided temporary relief for contract modifications and hedging requirements under U.S. GAAP. However, an entity’s eligibility to use the relief would be precluded for any modifications not related to the replacement of a reference rate that could affect the amount or timing of contractual cash flows. While we anticipate additional modifications of financial instruments related to COVID-19 impacts, companies should be mindful of the potential accounting ramifications if contract modifications encompass both adjustments for removing LIBOR and other modifications. In addition, we expect that some companies may consider strategically separating the timing of any reference rate from COVID-19 modifications to ensure their eligibility for the FASB’s relief related to reference rate reform. (See additional discussion of reference rate reform.)

As in prior months, we have observed modifications made by lenders to defer or delay the payment of principal or interest on outstanding loans for a certain period (a “payment holiday”). Some companies have experienced challenges with assessing default risk and the likelihood that the counterparty will comply with the contractual terms after these payment holidays. As these modifications for payment holidays or additional relief come to an end, companies should evaluate whether there are new or continued indicators that the debtor may be experiencing financial difficulties even though the debtor is not currently in payment default for the previous modifications.

In the past several months, many companies have applied for the Employee Retention Credit (ERC) offered under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. An application for the ERC can be filed retroactively for prior periods and, accordingly, we expect to continue to see a number of companies pursue this form of government assistance. While the ERC is designed to broadly apply to all companies, understanding the eligibility criteria may not be intuitive, particularly on the basis of a quick read of the appropriate CARES Act provisions.

Although some companies are continuing to see the recovery of their share price, they must still assess the potential need for impairment charges, which includes considering broad economic indicators in addition to their specific facts and circumstances. In that same spirit, certain companies may need to increase their focus on the future realizability of deferred tax assets, along with their ability to continue as a going concern, as a result of significant incurred and projected losses. (See additional discussions of impairments, income taxes, and going-concern considerations.)

Since many government-supported employment programs are scheduled to expire shortly, companies are continuing to contemplate various restructuring activities and could potentially undergo employee terminations and other reorganizational activities. In addition, companies continue to face operational challenges due to supply chain disruptions and health concerns, resulting in idle production capacity and vacant facilities along with the related financial statement impact. (See additional discussions of employee termination benefits and exit or disposal costs.)

Many companies continue to renegotiate the terms of existing contracts and arrangements as part of addressing the impact of COVID-19. The most frequent examples include leases, contracts with customers, and the terms of financial arrangements. Of particular note, if companies encounter even further delays in the timing of forecasted transactions designated as hedged items, they may experience additional pressure related to whether forecasted transactions will still occur within a reasonable period.

We continue to see many companies receive different forms of government assistance along with insurance recoveries. Under the Paycheck Protection Program in the CARES Act, a number of companies have accounted for monies received as debt rather than a government grant because of the uncertainty associated with the repayment of such funds. (See additional discussions of the CARES Act and insurance recoveries.)