Impact of the Coronavirus (COVID-19) Pandemic on Financial Statement Disclosures
(Entities with period-ends on or before December 31, 2019)
By Sara Carlson, Partner, Assurance Services & Qiqi Wei, Partner, Assurance Services
The impacts of the current COVID-19 pandemic are presenting challenges for many entities throughout the nation. All entities should be thinking through these challenges as they work on issuing interim or year-end financial statements. Many calendar year-end entities may be aware of impacts on their operations and financial positions as a result of the coronavirus crisis. However, it is likely that entities will not know the full extent of any financial impact yet, although enough may be known to determine that some level of disclosure would be required to inform the reader of material information that may impact the financial statements for periods after the balance sheet date. Said another way, if an entity has yet to issue its December 31, 2019, financial statement, there could be a material subsequent event that has been identified as relates to the COVID-19 pandemic. Concerns and potential issues that should be considered before disclosures are drafted may include:
- Location closures
- Loss of customers
- Supply chain interruptions
- Production delays
- Regulatory changes
- Workforce changes
- Risk of loss on significant contracts
- Potential future impairments of assets and/or market value declines
In order to conclude what types of disclosures may specifically be required, further analysis is needed. To assist with this, the following considerations and examples may be useful. Entities should evaluate all known impacts first and then determine what type(s) of disclosure is most appropriate.
Subsequent EventsAll companies will need to evaluate the impacts the COVID-19 pandemic may be having on their operations using the guidance in ASC 855, Subsequent Events. Subsequent events are events that occur after the balance sheet date but before financial statements are available to be issued. There are two types of subsequent events defined in the literature.
- Type I: Consists of events that provide additional evidence about conditions that existed at the balance sheet date, including the estimates inherent in the process of preparing financial statements. (recognized subsequent events)
- Type II: Consists of events that provide evidence about conditions that did not exist at the date of the balance sheet, but came about after that date. (non-recognized subsequent events)
Should the impact of the COVID-19 pandemic be accounted for as a type I (recognized) or a type II (non-recognized) event for entities with calendar year end of December 31, 2019?
Prior to December 31, 2019, the only in information that was known, was that researchers in China had identified a new virus that had infected dozens of people in Asia. There was no was no evidence at that time that the virus was readily spread by humans or that there would be an impact on the global economy. The subsequent spread of the virus and the escalation of it becoming a global pandemic did not occur until subsequent to December 31, 2019, as such, it should be considered as a type II (non-adjusting) event.
What extent of disclosure may be required as it relates to the COVID-19 pandemic?
Entities shall evaluate the need to disclose the related impact if it is required to keep the financial statements from being misleading to users of the financial statements. The placement and type of disclosure could largely be dependent on the industry the entity is operating in and/or the expected impact the COVID-19 pandemic may have on its business. For SEC Registrants, disclosure would need to be considered within risk factors, MD&A as well as within press or earning releases. If an entity cannot determine whether a material trend or uncertainty is reasonably likely to occur, it must assume that the uncertainty will occur and disclose any associated material future effects.
Some Type II subsequent events may be so significant or of a nature that financial statement disclosure is required to prevent the financial statements from being misleading. If the decision is made to disclose, the disclosure should generally include: the nature of the event and an estimate of the financial statement impact (or disclosure that the estimate cannot be determined at this time).
As the COVID-19 pandemic is having an impact on most entities. The most common categories of subsequent event disclosures that may be needed are included below. They include areas such as:
- Market value declines: historically, a general disclosure regarding the volatility in the stock market is not common, especially for non-public entities. However, the recent volatility and overall decline in market values, may have a more significant impact on an entity’s recognized assets. If an entity is going to include such disclosure, they should be aware of the requirements of ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.
- General business impacts: The most common disclosure will be a general statement regarding the impact to the entity of the COVID-19 pandemic. This may include descriptions of: a general reduction in sales, closure of operations, supply chain disruptions, or an inability of customers to pay, among others. Most likely the entity will not be able to quantify the related impact and should state that within the disclosure.
Other Disclosure Topics
The ability of an entity to continue as a going concern is effected by many factors. The impact of the COVID-19 pandemic may be impacting some of the factors that the entity has historically relied on to evaluate their ability to continue as a going concern for the upcoming year. ASC 205-40, Disclosures of Uncertainties About and Entity’s Ability to Continue as a Going Concern requires such an analysis to be performed up through the date that the financial statements are issued, as the look forward period is one year from the date the financial statements are issued. For any financial statements not yet issued, the impact of the COVID-19 pandemic on the entity will need to be included in the analysis.
With circumstances changing on a daily basis, with severe impacts happening in some sectors and industries, projections required to conclude as to whether substantial doubt may exist about the entity’s ability to continue as a going concern are very challenging. The entity will need to ensure the assumptions used in building the projections use the most current information available. Some things that should be taken into account include – the impact on the business from any shutdowns or quarantines, the implication of recently issued federal laws and changes to the tax code, and the status of companies within the supply chain as well as customer operations. The auditors responsibility mirrors that of the entity, so they will be following behind and doing work to ensure the projections used in the analysis and related disclosure include details regarding such assumptions. Given the rapid changes, the entity will need to be monitoring the going concern assessment, conclusion and disclosures closely up to the point of issuance.
Risks and Uncertainties
ASC 275, Risks and Uncertainties, requires disclosures that focus on risks and uncertainties that could significantly affect the amounts reported in the financial statements in the short-term operations of the entity. These could come from areas including: nature of operations, significant estimates used, and current vulnerabilities caused by concentrations. The COVID-19 pandemic may impact any or all of those areas for an entity. If a material impact is expected, a separate disclosure within the risk and uncertainties footnote may be required.
ASC 450, Contingencies, requires disclosure of the nature of a contingency when there is at least a reasonable possibility that a loss has been incurred. For contingencies that meet the threshold for disclosure but no liability has been recognized, entities must disclose an estimate of the possible loss or the range of possible losses (or state that such an estimate cannot be determined).
During this time of uncertainty as a result of the COVID-19 pandemic, a lessee may be unable to meet their lease obligations and the lessor and lessee may decide to modify the terms of a lease. When this occurs after the balance sheet date but prior to the date the financial statements are available for issuance, ASC 840-10-35-4, Leases should be considered. The standard requires the lessee and lessor to analyze lease modifications to determine whether the modified provisions, when applied at the inception of the lease, would have resulted in a different lease classification at the inception of the lease. In cases where the new lease standard has been adopted, using ASC 842-10-25, Leases, the lessee would need to determine whether the lease modification will be accounted for as a separate contract or as a change to an existing contract. If the impact is material, whether under ASC 840 or ASC 842, subsequent event disclosure would be required.
Additional considerations for SEC registrants: disclosure considerations for Form 10-K/20-F:
- Risk Factors: Per SEC guidance, risk factors should be tailored to the specific registrant and its business, as opposed to being generically applicable to any registrant or offering. The more susceptible a company is to the impact of COVID-19, the more tailored disclosures shall be.
- MD&A: Companies shall customize their COVID-19-related disclosures for their business and industry and companies that are materially affected by COVID-19 should include MD&A disclosures related to the current and potential future impact on their operations, financial condition, or liquidity.
Accounting and Disclosure Considerations for Periods Ending after January 1, 2020
While all of the considerations and disclosures above would still apply, there may be additional accounting and disclosure implications for the entities. The accounting and disclosure requirement should be specific to the entity’s businesses and not an overly broad account of the COVID-19 pandemic and general economic impacts. The entity should consider the following areas when considering the adequacy of their accounting analysis and related disclosures [a separate document on Accounting Implications is forthcoming]:
- the impact to its revenue recognition (such as lost revenue);
- potential inventory write-downs and impairment losses;
- Idle capacity and vacant facilities;
- loan defaults or covenant breaches, or amendments or waivers to lending agreements;
- changes in credit risk of customers or others negatively impacted by current developments and collectability of its accounts receivable balance;
- potential insurance recoveries (for any business interruption policies);
- changes in business or economic circumstances that affect the fair value of financial and nonfinancial assets and liabilities;
- changes in growth forecasts and discount rates that may impact impairment evaluations (e.g., goodwill, other intangible assets);
- going concern, and
- strategies and policies to manage evolving developments.
Sample disclosures by industry and link to see the full SEC filing (Included in December 31, 2019 Filings):
1. Retail – Lowes – Form 10-K Filing date 3/23/2020
Risk Factors: In addition, although we are monitoring the effects of a widespread outbreak of a contagious respiratory illness caused by a novel coronavirus first identified in Wuhan, China (COVID-19), we cannot predict whether, for how long, or the extent to which the outbreak may disrupt our supply chain, operations, sales, and/or product shipments and home installations. A prolonged outbreak could negatively impact our vendors and customers, cause interruptions to our operations, including the reduction of store operating hours, temporary store closures and reduced store traffic, and adversely affect our results of operations. More generally, a widespread health crisis could adversely affect the U.S. economy, resulting in an economic downturn that could decrease consumer confidence and affect demand for our products and therefore impact our results, including our business and financial outlook for fiscal 2020. Any adverse impact on our results of operations, business or financial outlook could be material.
NOTE 19: Subsequent Events
On March 11, 2020 the World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and recommended containment and mitigation measures worldwide. As of the date of this filing, our Lowe’s operated home improvement stores remain open in both the US and Canada, subject to regulated or reduced store hours. We cannot reasonably estimate the length or severity of this pandemic, or the extent to which the disruption may materially impact our consolidated financial position, consolidated results of operations, and consolidated cash flows in fiscal 2020.
2. Supply Chain – Marvell Technology Group Ltd. – Form 10-K Filing date 3/23/2020
Risk Factors: WE ARE SUBJECT TO RISKS ASSOCIATED WITH THE NOVEL CORONAVIRUS (COVID-19)
We face risks related to Novel Coronavirus (COVID-19) which could significantly disrupt our manufacturing, research and development, operations, sales and financial results.
Our business will be adversely impacted by the effects of the Novel Coronavirus (COVID-19). In addition to global macroeconomic effects, the Novel Coronavirus (COVID-19) outbreak and any other related adverse public health developments will cause disruption to our international operations and sales activities. Our third-party manufacturers, suppliers, third-party distributors, sub-contractors and customers have been and will be disrupted by worker absenteeism, quarantines and restrictions on our employees’ ability to work, office and factory closures, disruptions to ports and other shipping infrastructure, border closures, or other travel or health-related restrictions. Depending on the magnitude of such effects on our manufacturing, assembling, and testing activities or the operations of our suppliers, third-party distributors, or sub-contractors, our supply chain, manufacturing and product shipments will be delayed, which could adversely affect our business, operations and customer relationships. In addition, the Novel Coronavirus (COVID-19) or other disease outbreak will in the short-run and may over the longer term adversely affect the economies and financial markets of many countries, resulting in an economic downturn that will affect demand for our products and impact our operating results. There can be no assurance that any decrease in sales resulting from the Novel Coronavirus (COVID-19) will be offset by increased sales in subsequent periods. Although the magnitude of the impact of the Novel Coronavirus (COVID-19) outbreak on our business and operations remains uncertain, the continued spread of the Novel Coronavirus (COVID-19) or the occurrence of other epidemics and the imposition of related public health measures and travel and business restrictions will adversely impact our business, financial condition, operating results and cash flows. In addition, we have experienced and will experience disruptions to our business operations resulting from quarantines, self-isolations, or other movement and restrictions on the ability of our employees to perform their jobs that may impact our ability to develop and design our products in a timely manner or meet required milestones or customer commitments. See the Risk Factor entitled “If we are unable to develop and introduce new and enhanced products that achieve market acceptance in a timely and cost-effective manner, our results of operations and competitive position will be harmed.” These disruptions may also impact our ability to win in time sensitive competitive bidding selection processes. See the Risk Factor entitled “We rely on our customers to design our products into their systems, and the nature of the design process requires us to incur expenses prior to customer commitments to use our products or recognizing revenues associated with those expenses which may adversely affect our financial results.”
3. Starbucks – Retail – Form 8-K to supplement its Q2 FY2020 Filing to provide the estimated impact of the temporary business disruption in China related to the current outbreak of coronavirus disease (COVID-19) on its financial results for the second fiscal quarter of 2020.
In the letter to its shareholder, Starbucks disclosed the information related to its China Store Closures and Re-openings; China Q2 FY20 Sales Trends; Estimated Q2 FY20 Financial Impact; China New Store Growth; and Global and Fiscal Year 2020 Outlook.
Please click on the following link to read the letter.
If you have any questions, do not hesitate to contact your Marcum audit professional or contact Sara Carlson at 312.632.5030 or email Sara.
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