Guidance and advice concerning the impact of COVID-19 on financial reporting continues to proliferate. While the details may not be of critical importance for most audit committee members, the general tone and direction of these papers, especially those issued by regulators, are a useful guide to issues that are likely to arise as a result of the pandemic.
On June 23, the SEC’s Division of Corporation Finance provided new guidance concerning the impact of COVID-19 on public company disclosure. On the same day, the SEC’s Chief Accountant issued a statement describing his office’s efforts to engage with financial reporting stakeholders and to promote high-quality financial reporting. The Chief Accountant’s statement discusses several financial reporting issues related to COVID-19. These staff papers constitute the third round of disclosure guidance from the SEC. See SEC Leadership Offers More COVID-19 Disclosure and Financial Reporting Guidance, April-May 2020 Update, and SEC Provides Public Companies with COVID-19 Filing Deadline Relief and Guidance on the Financial Reporting Effects of the Virus, February-March 2020 Update.
In addition, on July 14, the Center for Audit Quality (CAQ) published an overview of the auditor reporting requirements and how COVID-19 could impact the types of audit reports issued. The CAQ previously issued CAQ Releases Key COVID-19 Auditor and Audit Committee Considerations, April-May 2020 Update.
SEC Division of Corporation Finance
On June 23, the staff of the SEC’s Division of Corporation Finance (Division) issued CF Disclosure Guidance: Topic No. 9A, Coronavirus (COVID-19) – Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources. The Division is monitoring disclosure of the effects and risks of COVID-19 on companies’ businesses, financial condition, and results of operations. The Division’s staff continues “to encourage companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change.” Disclosures should permit investors to understand how management and the board are analyzing “the current and expected impact of COVID-19 on the company’s operations and financial condition, including liquidity and capital resources.”
Topic No. 9A expands on the guidance issued in March. Topic 9A highlights four issues:
Operations, liquidity, and capital resources. Changes in operations, such as telework, supply chain adjustments, and suspending or modifying operations, may have effects that would be material to an investment or voting decision and should be considered for disclosure. Also, financing activities in response to the effects of COVID-19 may include novel terms and structures. Companies should provide “robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties to their businesses.” Even if disclosed elsewhere, consideration should be given to whether information regarding financing should also be included in manage-ment’s discussion and analysis of financial position and results of operations (MD&A).
Disclosure considerations. In analyzing their disclosure obligations, companies should consider a broad range of questions. The Division suggests over three dozen such questions, organized under 11 bullets. For example:
o What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? How and to what extent have you altered your operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace?
o How is your overall liquidity position and outlook evolving?
o Have COVID-19 related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods?
o Are you at material risk of not meeting covenants in your credit and other agreements?
o Have you reduced your capital expenditures and if so, how? What is the short- and long-term impact of these reductions on your ability to generate revenues and meet existing and future financial obligations?
o Have you altered terms with your customers, such as extended payment terms or refund periods, and if so, how have those actions materially affected your financial condition or liquidity?
o Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow?
Government assistance. Companies receiving federal assistance should consider the short- and long-term impact of that assistance on their financial condition, results of operations, liquidity, and capital resources, as well as related disclosures and critical accounting estimates and assumptions.
Going concern. Management should consider whether conditions and events, taken as a whole, raise substantial doubt about the company’s ability to meet its obligations as they become due within one year after the issuance of the financial statements. Where there is substantial doubt about a company’s ability to continue as a going concern or the substantial doubt is alleviated by management’s plans, management should provide the appropriate respective disclosures in the financial statements and consider the impact on MD&A disclosure. (The Chief Accountant’s statement makes similar points – see below.)
SEC Chief Accountant
In Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19, the SEC’s Chief Accountant, Segar Teotia, supplements his prior comments on pandemic-related accounting and auditing oversight activities. See SEC Leadership Offers More COVID-19 Disclosure and Financial Reporting Guidance, April-May 2020 Update. Mr. Teotia’s statement discusses four broad topics – the work of the Office of the Chief Accountant’s (OCA) related to high-quality financial reporting; engagement with the FASB and the PCAOB; engagement with international standard setters and other regulators; and the role of audit committees. From the perspective of audit committee financial reporting oversight, four points in the statement are of interest:
· Significant estimates and accounting judgements. The COVID-19 crisis has added to the challenges of making significant accounting judgments and developing estimates in a variety of areas. OCA “has consistently not objected to well-reasoned judgments.” However, companies should ensure that their disclosure regarding judgments and estimates “is understandable and useful to investors and that their financial reporting is consistent with the facts and circumstances.”
Importance of disclosure controls and procedures and internal control over financial reporting. Companies need to consider the impact of the pandemic on the operation and testing of controls, including in the risks of operating effectively in a telework environment. In addition, new or enhanced controls may necessary to mitigate risks arising from business changes. Any material change in internal control over financial reporting must be disclosed in the quarter in which it occurred.
Going concern disclosure. In each reporting period, management should consider whether there is substantial doubt about the entity’s ability to meet its obligations as they become due during the next year. If there is substantial doubt about the company’s ability to continue as a going concern, management should consider whether its plans alleviate such doubt and make appropriate disclosure to inform investors.
Vital role of the audit committee. Mr. Teotia emphasizes the role of audit committee oversight during the current crisis: “In these times of rapid change and increased uncertainty, the need for the oversight role that audit committees play is as critical as ever. The most effective audit committees are engaged, executing their responsibilities with diligence, and this engagement significantly enhances the financial reporting output. We continue to emphasize the important role of the audit committee throughout our interactions with participants across the financial reporting system and we welcome continued feedback directly from this important stakeholder group.”
Center for Audit Quality
On July 14, the Center for Audit Quality released Auditor Reporting: COVID-19 Considerations. This publication provides a high-level overview of the auditor reporting requirements and how COVID-19 could impact audit reports. As the CAQ notes, the “COVID-19 pandemic and the related market conditions create many new uncertainties for auditors, audit committees, investors and management of public companies” and has affected “public company financial statements in different ways and at differing levels of severity depending on an entity’s capitalization, geographic location and the industry in which the entity operates, among other factors.” The CAQ explains potential impacts on the auditor’s report, including:
Unqualified audit opinion with explanatory paragraph. In some circumstances, the auditor may be required to include an explanatory paragraph in the opinion. The most common such circumstance is where the auditor believes that there is substantial doubt about the entity’s ability to continue as a going concern. “This is one example of a potential impact on audit reports stemming from COVID-19 and the resulting economic uncertainty as companies may face challenges that could impact their ability to continue operating as a going concern.” Another example is the situation in which other information included in documents that contain financial statements is materially inconsistent with information in the financial statements.
Unqualified audit opinion with an emphasis of a matter paragraph. An emphasis of matter paragraph may be included in an audit report at the auditor’s discretion. Such paragraphs in public company audit reports are rare. The CAQ suggests that an emphasis of matter paragraph might be used where the company has adequately disclosed substantial doubt about its ability to continue as a going concern as a result of COVID-19, but the auditor determines that the going concern disclosures are “of such significance that an emphasis of matter paragraph in the audit report is necessary.”
Qualified audit opinion. In the COVID-19 environment, a qualified opinion could be required if the auditor concludes that the financial statement disclosures with respect to the entity’s ability to continue as a going concern are inadequate. Another example would be a situation in which the pandemic has caused a scope limitation, such as an inability to observe material inventory balances in circumstances where alternative methods, such as video technology, were not available or practical. (It should be noted that the SEC generally will not accept a qualified opinion.)
Critical Audit Matters. A CAM is any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment. The auditor’s opinion is required to include discussion of CAMs for large accelerated filer audits of fiscal years ending on or after June 30, 2019, and for other public company audits of fiscal years ending on or after December 15, 2020. The CAQ suggests that “the pandemic could increase the subjectivity and complexity of a specific audit area such that it meets the definition of a CAM, when it otherwise may not have prior to the pandemic.” In addition, CAMs that were previously identified may need to be “expanded to include new assump-tions that were especially challenging or complex due to the pandemic and/or result in changes to the auditor’s response to a previously identified CAM.”
Comment: Audit committees may want to focus particularly on the questions in Topic 9A that the Division staff suggests companies consider in analyzing the impact of COVID-19 on their disclosures. While these questions generally reflect issues that management needs to address in preparing its disclosure, they could also be used as a roadmap for dialogue between the audit committee and management concerning new disclosure challenges. The reminders concerning the disclosure implications of pandemic-related changes in business processes and controls and the need to consider MD&A disclosure of issues reflected elsewhere in SEC filings are particularly important. All three papers also underscore the fact that, in some cases, companies and their audit committees may need a refresher course on the disclosure ramifications of doubt concerning a company’s ability to continue as a going concern.