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This article identifies some of the accounting and disclosure issues the SEC is most likely to examine post-crisis, and suggests some steps issuers can take now to minimize regulatory scrutiny down the road.
Accounting Areas of Focus
The Office of the Chief Accountant and the Division of Corporation Finance have issued statements and guidance on accounting areas that may require companies to make significant judgments and estimates in light of the evolving status of COVID-19.
While the Office of the Chief Accountant's statement indicated that it will apply its historical perspective of not objecting to well-reasoned judgements, issuers and their auditors should take note of certain accounting areas more likely to require such judgments and estimates in the current situation.
The carrying value of assets on the balance sheet requires ongoing scrutiny, analysis and judgement, and the severe economic impacts of COVID-19 require preparers and auditors to make these assessments amid heightened uncertainty and volatility. Issuers should focus on the following:
Fair Value Accounting
A wide range of assets involve fair value assessments under generally accepted accounting principles (e.g., financial instruments, intangibles and business combinations), requiring complex fair value analyses, significant judgements and assumptions, and reliance on items such as comparable market transactions and future cash flow projections that will be significantly more uncertain and volatile amid COVID-19.
Asset Impairment Decisions
A wide range of assets (e.g., goodwill, long-lived assets and investment securities) require impairment assessments annually or based on GAAP-specified triggering events. The SEC has historically scrutinized both the timing and the amount of impairment assessments. These timing and valuation decisions may rank among the most important and difficult amid COVID-19 uncertainties.
Asset Allowances and Reserves
GAAP requires allowances and reserves to be recorded against a wide range of assets (e.g., receivables, inventory, loans and deferred tax assets) to ensure they are carried at net realizable value.
The judgements required in estimating these required allowances and reserves will require rigorous analysis and assessment, particularly regarding whether historical trends and experiences are appropriate bases of estimation in light of elevated levels of future economic uncertainty.
Properly and conservatively reflecting liabilities required by GAAP also requires significant analysis and judgement, and COVID-19 uncertainties will likely require preparers and auditors to assess both the need to record additional liabilities, and the carrying value of existing liabilities.
Issuers should focus on the following:
Debt Modifications or Restructurings
Many issuers may seek debt modifications or restructurings from lenders due to the sudden and significant impacts of COVID-19. GAAP has very specific rules for debt modifications, extinguishments and troubled-debt restructurings, all of which require significant technical analysis and judgement in order to properly reflect the impact of any such modifications or restructurings.
Issuers initiating business restructuring programs and plans triggered by current economic uncertainty should take note of the very specific GAAP rules for establishing, measuring and taking charges against restructuring reserves, including the treatment of employee termination, contract termination, facility and relocation costs, among others.
The accounting for and disclosure of loss contingencies (e.g., legal exposures, environmental remediation and toxic tort exposures) can be one of the most difficult and judgmental areas of GAAP, particularly determining whether a contingency is both probable and reasonably estimable, and therefore requiring accrual on the balance sheet.