Monetary Reporting and Auditing Implications of the COVID-19 Pandemic

Use of estimates.

One theory that pervades the problems bobbing up from the pandemic is using estimates to make sure well timed economic reporting. As mentioned beneath, lots of the problems would require greater-than-usual reliance on accounting estimates; because of the upper degree of uncertainty, those estimates will probably be inherently harder and not more dependable.

Auditors will have to workout really extensive skilled skepticism and vigilance, staying alert for indications of control bias, intentional or now not, in its estimates. As an example, it’s common to be overly conservative in a nasty yr when offering for loss contingencies, to facilitate stepped forward profits in a succeeding duration. (When intentional, this fraudulent observe is referred to as “taking a large bathtub.”)

Each and every time economic statements are to be issued, just about all estimates carried ahead from prior sessions will wish to be revisited within the mild of COVID-19 dangers and trends, topic to the accounting and disclosure provisions of Accounting Requirements Codification (ASC) Subject 250, “Accounting Adjustments and Error Corrections.”

For an accounting estimate to be appropriate as cheap via an auditor, it will have to be supported via enough purpose proof to allow a conclusion that it’s according to the most efficient data to be had on the time the economic statements are issued and is unfastened from control bias. The latter involves cautious menace evaluation and the workout {of professional} skepticism.

If control’s absolute best estimate is seen as topic to subject matter variability, that truth must ordinarily be disclosed, no less than qualitatively. When a single-point estimate pertains to a loss contingency, its further most publicity to loss must be disclosed if conceivable. FASB’s Conceptual Framework for Monetary Reporting states that “if the extent of uncertainty … is satisfactorily massive, that estimate is probably not specifically helpful” (Ideas Remark 8, para. QC 16). If inadequate proof is to be had, and no cheap estimate will also be made, that truth ordinarily must be disclosed. In some excessive cases, on the other hand, the shortcoming to make an estimate would possibly represent a subject matter scope limitation that essentially results in a certified, or a disclaimer of, opinion via the auditor [AU-C 705 or Auditing Standard (AS) 3105]. Record changes because of scope barriers are in most cases now not appropriate to the SEC as a result of they’re seen as noncompliant with federal securities rules.

As of this writing, the AICPA’s Accounting Requirements Board (ASB) and the PCAOB have just lately proposed () or issued amendments meant to give a boost to their respective requirements controlling the character and extent of audit procedures required to toughen control’s estimates. Those requirements (AU-C 540 or AS 2501) and the phenomenal proposed modification to AU-C 540 find the money for really extensive helpful steerage to auditors. (AS 2501, in its newest shape, is these days scheduled to transform efficient for audits of monetary statements for fiscal years finishing on or after December 15, 2020.)

Chance evaluation.

Audit effectiveness is extremely dependent upon the auditor’s skill to spot dangers of subject matter misstatement, and design and put into effect suitable responses that adequately cope with the ones dangers. In reference to the danger evaluation procedure carried out in each and every audit, cases surrounding the COVID-19 pandemic will wish to be intently tested in nearly all audit spaces. Correctly carried out, this workout will determine a number of new or heightened dangers of subject matter misstatement, lots of which can be mentioned beneath, that will have to be addressed when designing an efficient audit scope. Auditors will wish to be specifically alert to cases that provide fraud dangers and subsequently require particular consideration.

Valuation of receivables, inventories, funding securities, and deferred tax belongings.

The curtailment of operations, diminishing liquidity, and different financial hardships these days being skilled via shoppers and debtors will have to be regarded as when valuing receivables for collectability and setting up allowances. Entities additionally must imagine the have an effect on of the downturn in economic markets and the intense volatility in honest marketplace values of traded funding securities pursuant to ASC Subject 820, “Truthful Worth Size.” For debt securities and fairness approach investments, the “other-than-temporary” impairment check must be implemented beneath ASC 320, “Investments—Debt and Fairness Securities,” or ASC Subject 323, “Investments—Fairness Way and Joint Ventures,” respectively. For fairness approach investments, the impairment valuation described in ASC Subject 321, “Investments—Fairness Securities,” is also elected; for loans and receivables, the strategies described in both ASC Subject 310, “Receivables,” or the brand new present anticipated credit score loss (CECL) fashion in ASC Subject 326, “Monetary Tools—Credit score Losses,” must be implemented. Lessors in sales-type and direct financing hire preparations must likewise observe the impairment checking out steerage prescribed for economic belongings in Subjects 310 or 326, as acceptable, when figuring out credit score losses on hire receivables.

On account of the global opposed results of the COVID-19 pandemic on financial task, many provide chains were interrupted, and the substitute value of stock pieces, relying at the {industry}, has risen or fallen materially. Dramatically decreased substitute prices would most probably have the impact of decreasing internet realizable values, or for inventories carried at LIFO or at the retail approach, marketplace values (as according to ASC Subject 330, “Stock”), marketplace call for, and even final salability concerns used for stock valuation. Production and development firms will most probably wish to expense overhead prices associated with decreased or idle manufacturing capability fairly than allocate them to stock, and plant shutdowns may save you a producer or contractor from assembly their commonplace manufacturing ranges or development targets or lead to extra stock on account of an incapacity to distribute or assemble product on a regular agenda. Any of those eventualities would possibly require stock writedowns. Control will have to additionally rethink the consequences on present uncertainties about long run operations at the valuation allowance supplied for any deferred tax belongings.

Impairment of goodwill, different intangibles, or long-lived belongings.

Penalties of the pandemic will also be seen in lots of bureaucracy, together with income discounts, provide chain disruptions, industry closures, paintings stoppages, important volatility in economic markets, higher publicity to credit score menace, and higher prices. Many trip, hospitality, retail, leisure, and different enterprises have skilled a major decline in running task; in some cases, companies were pressured to near briefly and most likely completely. It’s unsure how lengthy those results will persist and the way fashionable they’ll be. All or any of those may well be signs of asset impairments.

Whilst there is not any thought of an “other-than-temporary” situation requirement for an impairment adjustment for those belongings (as there may be for investments in economic securities), temporary disruptions would possibly not point out an impairment. For an anticipated extended suspension of actions, on the other hand, those elements may point out impairment of positive nonfinancial belongings that control and auditors will wish to imagine.

ASC Subject 350, “Intangibles—Goodwill and Different,” calls for entities to check goodwill and different indefinite-lived belongings for impairment if “an match happens or cases exchange that might much more likely than now not [i.e., a greater than 50% chance] cut back the honest price of a reporting unit beneath its sporting quantity” (i.e., “triggering” prerequisites or occasions). Valuation tactics prescribed via the usual are past the scope of this dialogue, however in most cases contain attention of ancient and estimated long run efficiency and prerequisites. This may increasingly most probably entail use of valuation experts (AU-C 620 or AS 1210).

Examples of triggering prerequisites or occasions acceptable to goodwill and different indefinite-lived belongings come with opposed adjustments in economic efficiency, criminal or political elements, entity- or industry-specific occasions, or marketplace concerns. Following such an match, control must imagine whether or not the direct and oblique results of COVID-19 require it to check and alter the sporting price of the asset for impairment between required annual checking out dates. Additionally, if there are any signs that an entity has modified (or expects to switch) its classification of an intangible asset from indefinite-lived to finite-lived because of COVID-19, an accounting adjustment is also required.

ASC Subject 360, “Assets, Plant, and Apparatus,” calls for entities to judge assets, plant, and kit and amortizable finite-lived intangibles, referred to jointly as long-lived belongings, for recoverability “every time occasions or adjustments in cases point out that its sporting quantity is probably not recoverable.” Due to this fact, entities will have to imagine whether or not the direct and oblique have an effect on of COVID-19 represent occasions that will require checking out long-lived belongings for recoverability, corresponding to 1) a vital lower out there value of the belongings, 2) a vital opposed exchange within the extent or way during which the belongings are getting used or their bodily situation, or 3) a vital opposed exchange within the industry local weather that might have an effect on the recoverability of the belongings’ sporting price. Along with impairment concerns, such adjustments may reason the estimated helpful lives of such belongings to be shortened for depreciation or amortization functions. If a lessee has followed ASC Subject 842, “Rentals,” the impairment necessities of Subject 360 may also follow to right-of-use belongings identified on leasing preparations recorded beneath Subject 842.

If control makes a decision to eliminate long-lived belongings, they must be categorized as held on the market after being written all the way down to their impaired honest price and both introduced one after the other at the face of the steadiness sheet or disclosed within the notes in line with ASC 360-10-45-14 or -10-50-3(e). If control makes a decision to promote or abandon positive belongings or execute a restructuring plan, it must account for prices related to go out or disposal actions beneath ASC Subject 420, “Go out or Disposal Value Tasks.”

As a result of essential changes to the sporting quantity of the reporting unit will have to happen previous to the goodwill impairment check, all nonfinancial belongings must be examined for impairment in a prescribed order, as follows:

• Indefinite-lived intangibles and different belongings outdoor of the scope of Subjects 350 and 360, corresponding to stock or capitalized prices to procure or satisfy a income contract
• Lengthy-lived belongings
• Goodwill.

Skilled judgment will have to be implemented to each and every discrete asset or asset team into consideration for an impairment write-down, and the foundation for conclusions, particularly when very little writedown is deemed essential, must be in moderation documented. That is specifically essential for issuers, because the SEC has been identified to problem the timing of impairment loss reputation (see, e.g., SEC AAER-4064).

Loss contingency accruals and disclosures.

The timing of popularity and disclosure of anticipated losses is ruled in most cases and essentially via ASC Subject 450, “Contingencies,” and in positive particular cases via Subject 855 and different steerage. A “loss contingency” is outlined in Subject 450 as an “present situation, state of affairs, or set of cases involving uncertainty as to conceivable loss to an entity that can in the end be resolved when a number of long run occasions happen or fail to happen.”

Accrual of a loss contingency (i.e., reputation of the loss) is needed when 1) the incidence of a number of such long run occasions is possible, and a couple of) the volume of the loss is topic to cheap estimation. Even though there are various perspectives concerning the quantitative that means of “possible,” Accounting Requirements Replace (ASU) 2014-15 means that, in an ASC 450 context, it’s meant to consult with no less than a 70% probability of incidence. If each standards for reputation don’t seem to be met, and the topic is subject matter, disclosure is needed. As well as, an entity must now not lengthen reputation of a loss on account of an incapacity to estimate a unmarried quantity; as a substitute its estimate of the minimal possible loss incurred must be collected [ASC 450-20-25-2(b)].

There are, on the other hand, exceptions. As an example, a loss must now not be collected upfront of enactment of proposed law, even though the entity believes such enactment to be possible or if enactment has passed off within the next duration.

Trade interruption insurance coverage recoveries.

Entities frequently handle insurance coverage to mitigate losses from industry interruption (i.e., disruption), corresponding to misplaced income all over sessions of suspended operations. Control would possibly imagine, rightly or wrongly, that losses from industry slow-downs or shutdowns, disruptions within the provide chain, or different penalties of COVID-19 are recoverable via such insurance policies. Such interruption losses, on the other hand, are generally lined handiest when related to bodily injury to lined assets. Absent such injury, whether or not expressly excluded via coverage language or now not, protection would most probably be denied until a selected clause or rider for losses brought about via illness or different screw ups used to be negotiated and permitted upfront of the loss and an extra—most probably important—top rate paid. Even then, there would most probably be qualifying prerequisites and barriers as to the level of restoration to be had.

Consistent with a piece of writing via Andrew G. Simpson (“P/C Insurers Put a Worth Tag on Exposed Coronavirus Trade Interruption Losses,” Insurance coverage Magazine, Mar. 30, 2020, ), in March 2020, New Jersey, Ohio, and Massachusetts had been making an allowance for law to drive carriers to pay for such losses for companies closed or limited on account of COVID-19; a bipartisan team in Congress has regarded as introduction of a reinsurance program. As well as, a number of court cases were initiated via policyholders searching for protection that used to be denied. However the insurance coverage {industry}, which sees its very economic viability threatened via such movements, is preventing laborious towards those measures within the state legislatures, Congress, and the courts, and the results don’t seem to be predictable.

Due to this fact, excessive warning will have to be exercised via auditors whose purchasers are proposing accruing or disclosing any subject matter anticipated industry interruption insurance coverage recoveries of their economic statements. Auditors will have to test such protection and its qualifying prerequisites and boundaries via reference to specific coverage language, via acquiring affirmation from the service or a certified insurance coverage agent, or within the match of probably disputed protection, via acquiring a criminal opinion from the customer’s suggest.

Correct accounting for insurance coverage recoveries varies, relying on elements corresponding to the character of the declare, the volume of proceeds (or expected proceeds), and the timing of the loss and restoration. When acceptable, estimated reimbursements for industry interruption are in most cases regarded as acquire contingencies topic to ASC 450-30, which calls for that such contingencies be resolved earlier than the sort of repayment will also be identified. Those contingencies could be regarded as resolved handiest when the proceeds have both been won or the predicted quantity has been showed via the insurer or a duly approved consultant.

Long term running losses.

There’s no alternative in U.S. GAAP for the accrual of anticipated misplaced revenues, except for within the type of industry interruption insurance coverage claims receivable when realization is confident. However, estimated long run running losses ordinarily must be disclosed to the level slightly conceivable. One must imagine, on the other hand, whether or not (and in what duration) to acknowledge dedicated prices and bills for which, because of the consequences of the industrial slowdown brought about via COVID-19, there is probably not any matching revenues approaching or items or services and products anticipated to be won in alternate. Examples of such dedicated prices or bills are temporary hire or depreciation on idle amenities and advantages for furloughed staff.

An entity that self-insures for scientific claims via its staff might also wish to imagine if it is slightly conceivable that, at its steadiness sheet date, a few of its staff have had publicity to COVID-19 that can lead to further scientific claims, and whether or not the estimated prices thereof wish to be collected as “incurred however nor reported.”

Tax results.

The CARES Act comprises a number of important provisions, together with however now not restricted to expanding the volume of deductible hobby for companies beneath Inner Earnings Code (IRC) segment 163(j), permitting taxable companies to hold again positive internet running losses (NOL) and lengthening the volume of NOL that companies can use to offset source of revenue. Those adjustments can have important results on an organization’s source of revenue tax provision, particularly when there are NOLs or segment 163(j) carryforwards and a valuation allowance towards deferred tax belongings.

ASC Subject 740, “Source of revenue Taxes,” calls for that the consequences of tax regulation adjustments be mirrored within the estimated annual efficient tax charge in meantime economic statements, the deferred tax attributes, and the tax accounts no previous than the duration of enactment (ASC 740-270-25-5 and -6).

Executive loans and different advantages.

The CARES Act permits small companies and not-for-profit entities that experience skilled or are anticipated to revel in considerably decrease income to be eligible for positive executive loans and grants. As an example, as of the time of this writing, the act supplies Small Trade Management (SBA) loans or grants for positive qualifying small companies and not-for-profit organizations with fewer than 500 staff to assist retain employees (e.g., via paying salaries and offering paid scientific go away and insurance coverage advantages) and pay money owed or for training and coaching. Underneath positive prerequisites, the SBA loans are eligible for forgiveness of quantities spent on stipulated advantages. As soon as in position, the phrases of those loans and grants, if subject matter, should be disclosed and compliance verified in long run audits. Consequences for noncompliance with mortgage or grant prerequisites should be regarded as for accrual or disclosure when acceptable.

Different employer advantages now not associated with source of revenue taxes come with 1) permitting employers to defer fee via December 2020 of the employer proportion of Social Safety payroll taxes payable over the next two years and a couple of) permitting eligible employers to obtain a 50% credit score on certified wages towards their employment taxes each and every quarter.

As a result of a few of these advantages are conditional upon restricting government repayment and likely advantages, some employers would possibly want to regulate preparations with extremely paid employees to agree to those limits, which would possibly lead to adjustment to in the past recorded quantities and disclosures. Adjustments or cancellations of positive share-based fee awards that both have in the past vested or are possible of vesting don’t require reversal of any repayment and would possibly outcome within the acceleration of in the past unrecognized repayment value. Entities would possibly wish to imagine what impact, if any, accepting executive help can have on control’s going worry analysis beneath ASC 205-40.

Reduction for economic establishments from positive GAAP provisions.

The CARES Act comprises provisions offering transitority reduction from positive GAAP necessities. A economic establishment would possibly elect not to follow GAAP necessities to mortgage changes linked to distressed debt restructurings bobbing up out of the COVID-19 pandemic (segment 4013). Insured depository establishments, financial institution retaining firms, or any associate thereof would possibly elect reduction from adopting ASU 2016-13, Size of Credit score Losses on Monetary Tools, till the sooner of the tip of the nationwide emergency or December 31, 2020 (segment 4014).