In the world of generally accepted accounting principles (GAAP), the term “triggering event” had been a subtle classification, or at least one that was difficult to clearly identify. Henceforth, there will be few events more worthy of the mantle “triggering event” than COVID-19. Beyond the countless scary and burdening consequences of a pandemic, there are most definitely significant issues to financial reporting – perhaps even going concern questions.
Millions of businesses have been closed, hoping and praying that the economic crisis is temporary. All levels of supply chain and distribution have been disrupted, creating havoc with inventories, equipment, and works in process. With few exceptions (grocery stores, toilet tissue producers, and sanitizer manufacturers, etc.), businesses are experiencing crushing pressures on revenues and cash flow; most have mounting debts and obligations, bank loans and lines of credit, and all-around payables; and significant pressures to assets, holdings, and retirement accounts. There is a deepening and pessimistic outlook as it pertains to recovery, recapturing the customer base, the loss of key human assets, and a level of fiscal uncertainty that few born after the Great Depression have ever seen.
CPAs will be working on financial reporting documents for some companies that are holding on and others that are in dire circumstance. CPAs compiling financial documents will report recent results but must also have an eye on near-term realities.
ASC 855, Subsequent Events, matters occur after the balance sheet date but before financial statements are issued (or available to be issued). They should be recognized as subsequent events if the matters/conditions existed at the balance sheet date, with the evidence or implications to the unfinalized financial statements provided; or as nonrecognized subsequent events if the matters/conditions did not exist at the balance sheet date, but will have a subsequent implication or will possibly affect the user’s understanding of said financial statements. If a nonrecognized subsequent event is so significant that nondisclosure would make the financial statement misleading (surely, COVID-19 fits this type), then disclosure must be made and include the nature of the event(s) and an estimate of the financial statement effect of the event(s) or include a statement that an estimate cannot be made.
The necessity for subsequent events assessment is not only required for financial statements in accordance with GAAP (or International Financial Reporting Standards), but also in any financial reporting framework, including a special purpose framework (SPF) such as income tax basis.
Here is an example of what a sample disclosure could look like:
As a result of the COVID-19 outbreak in the United States, economic uncertainties have arisen that are likely to negatively impact gross revenues and income. Voluntary, and then subsequently mandatory, shelter-in-place orders necessitated temporary business closing as the uncertainty continues. Though the extent of disruption is expected to be temporary, the extent of the financial impact and other possible impacting matters are unknown at this time.
The impact of the pandemic on assets has been, or may rise to, quite a significant impairment, particularly in the asset areas of ASC 350, Intangibles-Goodwill and Other, and ASC 360, Property, Plant, and Equipment. Both of these asset classifications necessitate impairment assessment upon occurrence of a triggering event. Possible repurposing of business assets or necessitated restrictions to operating usage (such as excess capacity leading to closing or sale of facilities and related property, plant, and equipment assets) could result in impairments.
Other asset impairments would be in investments (ASC 320, 321, and 323), collection vulnerabilities (Topic 326, Credit Losses), and the net realizable value on inventories (ASC 330). For early adopters of ASC 842, Leases, there may be an impairment right out of the chute based on potential declines in the real estate market. Additionally, management’s assessment of purchase or lease extension options could immediately impact the right-of-use asset and lease liabilities under ASC 842, or the other matters disclosure information for the majority still applying ASC 840.
Just as nonpublic companies had adopted and applied ASC 606, Revenue from Contracts with Customers, all the levels of Step 3 in determining contract price – which may have components of variable consideration, awards and bonuses, and the entirety of the collectability of the amount expected – may necessitate reconsideration as a Type I subsequent event.
Risks and Uncertainties
ASC 275, Risks and Uncertainties, calls for disclosure of risks and uncertainties that could significantly affect amounts reported in financial statements. COVID-19 could impact numerous areas, from actual business lines, distribution centers, regional locations, possible deep discounts or concessions, industry vulnerabilities and concentrations, cost allocations, or even financial debt covenants. If provisions for loss contingencies (ASC 450) to recorded, identified, or other amounts determine a reasonable possibility that a liability would be incurred, these disclosure requirements also would impact SPF reporting framework (tax basis) financial statements.
With the passage of recent legislation (including the CARES Act), there are additional provisions and considerations for current and/or deferred taxes relative to loss carrybacks, increased interest expense limits, or potential credits for prior corporate minimum taxes. For more information on both federal and state taxes, check out our Federal Tax column and our feature on state and local tax issues during the economic downturn.
An entity’s ability to continue as a going concern is not just a relatively new accounting principle adopted by GAAP; it is a significant professional performance standard in almost all reporting engagements. Matters relevant to the internal working of the entity, as well as the entity’s customer base, supply chains, and ability to meet and/or obtain necessary financial debt support to pull through the pandemic’s economic crisis will be huge. Evaluations are based on events that are known and reasonably knowable, but quick-to-issue approaches to financial statements may be professionally questionable as more implications are learned as time goes on and the crisis remains prominent within the United States.
Audit guidance contained in AU-C 570, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, necessitates assessment and consideration for one year from the date the financial statements are available to be issued. In GAAP financials, management’s representations and plans must be carefully considered, assessed, and documented. Even Statement on Standards for Accounting and Review Services stepped up the magnification of responsibilities, particularly in a review (AR-C Section 90). However, both a compilation (AR-C Section 80) and a preparation (AR-C Section 70) necessitate that the CPA has sufficient knowledge to know whether omission of any going concerns disclosure would be misleading; if so, the financial statements must either be revised or the CPA must resign from the engagement.
Even though an SPF reporting framework such as tax basis may not specify a management representation as an accounting principle, the economic implications of COVID-19 may mandate that consideration be applied.
James J. Newhard, CPA, is a sole practitioner in Paoli, a CPE presenter for Kaplan Financial Education, and a past-president of PICPA’s Greater Philadelphia Chapter. He serves on numerous state and chapter A&A and tax committees, and is a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org or @CatalystJimCPA.