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Accounting* For Impact of Coronavirus Disease of 2019

accounting for impact

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Accounting* For Impact of Coronavirus Disease of 2019

accounting for impact

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Understanding the direct and indirect effect of COVID-19 can prepare the company’s operations, future plans, and key information communicated to stakeholders.

The Coronavirus Disease of 2019, or COVID-19, is an evolving concern that has dealt a huge blow in the Global Financial Market and industries in general, disrupting value chains and daily living of the world’s population. Originally declared as a public health emergency on January 30 by the World Health Organization, the phenomenon is now considered as a Pandemic, and full impact remains evolving. As it affects and creates a toll on human activity and quality of living in general, COVID-19 poses great uncertainty to other facets of businesses. Directly, we have seen the effects in the companies’ supply chains as it halts workforce, production of goods and rendering of services, and forces governments to regulate economic activities. Further, we have identified selected indirect effect on the companies’ financial statements that may pose significant effects in the long run.

FASTalks is here to affix your senses on things that matter to your stakeholders, and ensure that your accounting* teams—the Scrubbed team— cover considerations that stakeholders might ask—because in times of crisis, stability and knowing the impact of uncertainties matter.

In a Nutshell

  • COVID-19 poses 2019 financial statement modifications on Going Concern (ASC 205-40) and Subsequent Events (ASC 855)

  • COVID-19 affects Revenue Recognition for Q1’2020 onwards (ASC 606 and 326)

  • COVID-19 presents accounting* for unusual expenses for Q1’2020 onwards (ASC 220 and 225)

  • COVID-19 opens uncertainties towards impairment of certain assets (ASC 350 and 360)

  • COVID-19 affects Lease Accounting* for Q1’2020 onwards (ASC 842)

  • COVID-19 required regulatory reforms by providing tax filing reliefs for State (CA) and Federal Tax Returns

2019 FINANCIAL STATEMENTS IMPACT

Consistent with ASC 855 provisions, companies should evaluate whether events occurring subsequent to the Balance Sheet date (12/31/2019) require disclosure or adjustments in the financial statement.

Managements’ action point is to consider the adjustment in the financial statement, via notes, or via adjusting financial amounts.

  1. Non-Adjusting Events / Nonrecognized Subsequent Events. For 12/31/2019 filings, financial reporting impacts will be limited to disclosures in the notes to financial statements. Examples include closure of facilities, change in debt arrangements or restructuring, change in business practices (such as movement to online channels), and modifications in covenants.

  2. Adjusting Events / Recognized Subsequent Events. Consistent with current practice, if the event is a culmination of an already existing event as of Balance Sheet date, example of which is the US-China trade restriction, then the financial impact of the event constitutes adjustment in the financial statement details as of 12/31/2019.

Significantly, for those not yet issuing the financial statements for 12/31/2019, a grave consideration is the factor of the identified uncertainty (COVID-19). Consistent with the provisions of ASC 205 Subtopic 40, a reporting entity’s exposure to coronavirus-affected areas may raise or contribute to other existing facts and circumstances that collectively raise substantial doubt about the entity’s ability to continue as a going concern.

Managements’ action point is to reassess the following:

  1. Assess whether liquidation accounting* is applicable (COVID-19 may have disrupted an entire industry, and lack of revenue-generating activities may affect the viability of the business);

  2. Consider whether impact of COVID-19 is material to the company’s ability to continue as a going concern (did it significantly alter the business model of the company?);

  3. Consider Managements’ plans to mitigate the adverse conditions or events;

  4. Consider effective implementation of managements’ plans and viability of resolving the substantial doubt as to the impact in the company’s operations.

Currently, 42% of SEC Issuers have included COVID-19 as incremental business risk and considered the factor in the companies’ abilities to continue as going concern. If positive outcome is expected based on the action points above, then a mere disclosure is required, considering that COVID-19 impacts the operations of the company materially.

CONSIDERING REVENUE RECOGNITION CONSTRAINTS OF COVID-19

Consistent with ASC 606 provisions, three factors affecting revenue recognition and subsequent collection must be taken into consideration when recognizing revenue for Q1’2020 onwards.

  1. Adjustment of Variable Considerations. Variable consideration is estimated at contract inception and needs to be reassessed at each reporting date. But variable consideration can only be recognized to the extent it is probable a significant reversal will not occur when the uncertainty is resolved. ASC 606 describes examples such as volume discounts, rebates, returns, refunds, and royalties, liquidating damages. Consideration is also variable if it is contingent on a future event and its occurrence, such as meeting performance goals or deadlines, or a customer achieving a certain outcome, such as a distributor meeting a target level of gross margin upon resale.

    Given the disruption in the supply chain, management is enjoined to consider the following: (a) adjust the rates of returns and refunds with some kind of forward-looking factor, as opposed to historically analyzing rates. In this view, retrospective analysis may need to be adjusted; (b) consider the probability of performance goals or deadlines not being met due to adverse effects in the economy.

  2. Assessment of Collectability of Contracts at Day 0. Salient provision of ASC 606 is to ensure that contracts must meet the collectability threshold—being probable. US GAAP defined “probable” as “likely to occur,” which is generally considered at 75% to 80% threshold. While it is a standard procedure to assess the bad-debts on occurring sales, it is a great concern as to whether the credit quality of the customers have been impaired at the onset of the sale/rendering of service.

    We opt to remind Management that revenue can only be recognized when collection of consideration is probable at the perfection of the contract/delivery of goods. This criteria must be met, and Management is encouraged to assess customers who are credit-impaired on Q1’2020, in order to address existence issues of revenues.

  3. Impairment of Receivables amidst COVID-19. While incurred losses model generally apply for private companies, it is important to note that ASC 326, guidance on current expected credit loss model (CECL), suggests that a forward-looking adjustment be considered in the computation of impairment of receivables.

    We encourage management to consider a forward-looking adjustment (e.g. adjustment of rates such as increase in expected impairment rate) related to overall credit deterioration of customers. Historical analysis (net flow rates) and previous credit profiling may not be applicable in the face of the pandemic, and we are encouraged to adjust our models accordingly.

ACCOUNTING* FOR UNUSUAL EXPENSES RELATED TO COVID-19

Unexpected costs are likely to be incurred because of COVID-19. In recognizing these expenses, ASC 220 and ASC 225 provide guidance on what items are considered “unusual” and “infrequent.”

“Unusual” events are those with high degree of abnormality that is clearly unrelated, or incidentally related to the ordinary activities of the business in its operating environment. On the other hand, “infrequent” events are those that are not reasonably expected to be incurred again in the future, within the operating environment.

The standard also classifies the operating environment to consider the characteristics of the industry, the geographical location and the governmental regulation. For example, an entity handling national disasters, may consider expenses from response for emergencies as part of their normal operations, and would not be classified as “unusual” or “infrequent”.

Examples of which are, but not limited to, the following:

  • Planning, preparation, and prevention activities for Management’s response to COVID-19

  • Cancellation of events and delays in the production costs

  • HR Expenses (additional security and staffing)

  • Increase in IT related expenses due to additional access management tools/remote work set-up

Management’s action point is to provide separate consideration in accounting* for these expenses.

When incurring unusual and infrequent expenses, generally, these expenses are presented as part of the statement of comprehensive income with supporting disclosure. A detailed list of the accounting* treatment for these items are summarized below in accordance with ASC 220:

  1. Presentation as a separate component of income from continuing operations, (not presented net of tax);

  2. Presentation as a separate component of the financial effect of unusual and infrequent events;

  3. Disclosure of unusual and infrequent expenses, including nature and circumstance; and

  4. Recognition of receivable/gain from insurance policies to the extent that the amount of losses has been recognized in the financial statements (ASC 450)

Our consensus with management disclosure and analysis is this: in order not to disrupt the performance measurement of some industries, these expenses should be considered outliers, and there should be a separation in the evaluation and management of key performance indicators (especially in the healthcare industry).

PROBABLE IMPAIRMENT OF ASSETS

Respective companies’ financial performance and future projections as to the health and wealth of the business may be significantly affected, either on the demand side or the supply side. Factors include:

  1. Demand Side.