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With the first quarter of calendar year 2020 behind us and prior to 10-Q filings, companies continue to respond to the unprecedented, abnormal disruptions to their daily operations and finance activities brought on by the COVID-19 pandemic. U.S. public companies will be issuing earnings releases and conducting analyst and investor calls. These reports will reflect uncertainties in business outcomes — and the elements of business that reduce that unpredictability, and provide continuity and stability.
PwC’s COVID-19 CFO Pulse Survey underscores the reality that the impacts of the pandemic on financial reporting are becoming more apparent. In total, 81% of US respondents expect to include a discussion of COVID-19 in upcoming external reporting. For those disclosures, nearly half plan to include such a discussion in risk factors (50%); financial statements, including footnotes (47%); and MD&A results of operations (46%). And approximately one-third in earnings releases (37%) and MD&A liquidity (32%).
One key aspect of the financial accounting framework that will help those in the capital markets better understand the impact of these uncertainties includes the company’s ability to continue as a “going concern.” Going concern assumes that a company has the resources needed to continue operating indefinitely until it provides evidence to the contrary. As a result, those who prepare the financial statements must consider the impact of abrupt interruptions caused by major or remote events like COVID-19 since those matters can threaten the existence of some companies — casting substantial doubt about its ability to continue as a going concern.
When we are engaged by companies as their external auditor, it’s our best practice to counsel them to provide as much information as practicable regarding their current financial and operating status, as well as their future planning in these areas. The market wants to know whether companies are operating and how they’re performing in the current environment — and, now more than ever, they want that information now. This urgency prompts the necessary evolution of how companies and market participants look at financial reporting in this new environment.
As companies continue to navigate this new (ab)normal operating reality, there are a few specific areas that merit additional focus:
Contextualizing and addressing judgmental issues in the accounting process
Financial statements are important because they enable a company to provide useful information during a given point in time to the capital markets. And a financial audit, if reasonable assurance is obtained, adds credibility to management’s representations in those financial statements. Access to markets, mergers, acquisitions, and investments depend on both these aspects.
During this challenging period, companies may need to make judgments and approximations to address impairments -- looking first to whether risk-based “triggers” have occurred. This could prompt companies to conduct impairment tests, supported in many cases by cash flow forecast and discount rates, which should be updated to reflect the risk and uncertainty in the business from the potential impact of COVID-19. Ultimately, the company should be realistic about the work ahead, possibly seek help if needed, and communicate often with the audit committee and external auditors.
In the case that COVID-19 has had a significant effect on the business but management has concluded a triggering event has not occurred for goodwill, it’s important that the external auditors and audit committees understand how management reached that conclusion.
The same applies when encountering goodwill. Since it’s tested at the reporting unit level it could be that a particular unit is not impacted by COVID-19, say it is producing essential products and/or has significant headroom, and as such, a trigger has not occurred. In this kind of scenario, management, audit committees and external auditors will want to understand the basis for the analysis.
Identifying and disclosing responses to liquidity risks
Given the current complexities and the significant judgments and estimates that may be required to properly evaluate the range of potential impacts, management must remain especially vigilant to ensure risks to liquidity remain a high priority. As auditors, we are pushing for a mindset of “disclose what you know'' and advise that companies disclose any risks and uncertainties that could significantly affect financial statement amounts in the near term. This can include disclosures on information on a company’s ability to fund operations for at least 12 months from the date the financial statements are issued, the likelihood of non-compliance with financial and/or nonfinancial debt covenants, any reductions in asset-backed lending capacity and potential or known credit downgrades that could result from reduced company performance.
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Practically, this means that an organization’s risk committee, which hasn’t historically played a central role in financial reporting, will need to work more closely with their colleagues in the audit and finance departments to consider the financial impact of COVID-19, including disruptions to supply chain, liquidity and capital resources, changes in significant estimates and significant events such as impairments.
Make no mistake, this is likely one of the most challenging financial reporting periods that many will experience. With uncertainties to address and even practical considerations such as the ability to close the books and meet regulatory filing deadlines via a remote workforce, companies need to take a holistic approach to assessing the impact of COVID-19 and market volatility to its financials. Considering the points made above and engaging the right level of external support, management, audit committees and external auditors can help ensure quality and consistent financial reporting which stakeholders throughout the capital markets can rely upon.
Wes Bricker, PwC Vice Chair, US and Mexico Assurance Leader