Disclosures Related To COVID-19 – SEC Updates

Last week the SEC Office of the Chief Accountant (OCA) made a public statement on the importance of high-quality financial reporting for investors in light of Covid-19 on the same day that the Division of Corporation Finance issued an updated Disclosure Guidance Topic No. 9A on operations, liquidity, and capital resources disclosures related to the virus.  Disclosure Guidance Topic No. 9A supplements the previously issued Topic No. 9 (see HERE) and follows the SEC’s virtual Investor Advisory Committee (“IAC”) meeting where investors testified as to additional information that should be relayed to the capital markets by public companies (see HERE).

OCA Statement on Financial Reporting

On April 3, 2020, the SEC Office of the Chief Accountant (OCA) made its first public statement on the importance of high-quality financial reporting for investors in light of Covid-19.  At that time, many companies were in the process of preparing Q1 results and reports.  Now that Q2 is coming to a close, the OCA has issued a new statement, specifically addressing (i) OCA’s engagement and work related to high quality financial reporting; (ii) engagement with the FASB and PCAOB; (iii) engagement with international standard setters and other regulators; and (iv) engagement with and the vital role of audit committees.

                OCA’s engagement and work related to high-quality financial reporting

Although high-quality timely financial information is important at all times, in times of uncertainty such as created by Covid-19 it is even more important.  During this time, many companies have been required to make significant judgments and estimates to address a variety of accounting and financial reporting matters.   OCA reiterates that it will not second guess well-reasoned judgments and encourages companies to continue to report judgments and estimates based on the company’s specific facts and circumstances.

All public companies are required to maintain disclosure controls and procedures (DCP) and internal controls over financial reporting (ICFR) (for more on ICFR, see HERE).  OCA emphasizes that both DCP and ICFR should be carefully reviewed and adapted to the changing environment.  These changes may include consideration on how controls operate or can be tested and if there is any change in the risk of the control operating effectively in a telework environment.

OCA reminds public companies about the need to consider and report any going concern issues.  Public companies should carefully consider their ability to meet its obligations as they become due within one year after the issuance of the financial statements.  Disclosures should include information about the principal conditions giving rise to the substantial doubt, management’s evaluation of the significance of those conditions relative to the entity’s ability to meet its obligations, and management’s remediation plans.  An annual audit report is required to address the company’s ability to continue as a going concern; however, GAAP specifically requires disclosures in the notes to financial statements as well, on both a quarterly and annual basis.  OCA reminds auditors that are reviewing quarterly financial statements to be cognizant of disclosures related to going concern issues and to be satisfied that they are sufficient in light of the circumstances.

OCA has processes in place to provide staff views on the application of U.S. GAAP and International Financial Reporting Standards (IFRS) to complex, unique or novel issues.  Since the Covid-19 crisis began, the SEC has consulted with many issuers on matters such as the financial reporting of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), debt modifications, hedging, consolidation, business combinations, lease concessions, revenue recognition and income taxes.  OCA believes that current financial reporting standards, together with the ability to seek consultation, adequately address the needs of companies and their financial reporting requirements.

Engagement with FASB and PCAOB

FASB is responsible for setting accounting and reporting standards for U.S. companies.  During the crisis, OCA has been working with FASB regarding emerging issues around Covid-19, though no particular reporting standard changes have been implemented.  In its statement, OCA applauds the PCAOB for its transition to remote operations and engagement with auditors that were likewise making the same transition.

                Engagement with International Standard Setters and Other Regulators

Financial markets are global in nature.  OCA notes that U.S. investors hold in excess of $11 trillion of foreign debt and equity securities.  The OCA public statement provides general information on the various international groups that OCA engages with, such as the IASB and the International Organization of Securities Commissions, but does not detail any particular Covid-19 initiatives.  In general, the International Federation of Accountants is preparing a proposal that would make audits more responsive to all stakeholders and not just equity shareholders, but this is not particularly Covid-related.

Engagement with Audit Committees

OCA emphasizes the importance of audit committees and the need for extra involvement and engagement on the impacts of Covid-19 to the particular financial reporting of each company.

Corporation Finance Topic No. 9A

Back in April, the SEC Division of Corporation Finance issued Disclosure Guidance Topic No. 9 regarding the SEC’s current views on disclosures and the obligations that companies should consider with respect to COVID-19.  Last week the SEC updated that guidance issuing Disclosure Guidance Topic No. 9A.  The overarching messaging is that a company must consider its COVID-19 impact in its disclosure documents based on that company’s specific facts and circumstances and make necessary material disclosures using a principles-based strategy.

A difference between Topic 9 and Topic 9A is that Topic 9 was focused on assumptions and considering future impacts, whereas, months later, Topic 9A includes a much more robust consideration of actual events and impacts to financial condition.

Many companies have undertaken or are in the process of undertaking a diverse range of operational adjustments in response to the effects of COVID-19.  Although each company has its own unique situation, examples of include transitioning to a telework environment, supply chain and distribution changes, and suspending and modifying operations to implement health and safety guidelines.  In addition, companies are engaging in differing financing activities in response to Covid including credit facilities, accessing public and private markets, supplier finance programs, modified creditor payments and modified customer receipt payments. It is important that companies provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks.

Topic No. 9A expounds upon the considerations for management when considering disclosures, including:

• 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? How are the changes impacting or reasonably likely to impact your financial condition and short- and long-term liquidity?
• How has COVID-19 impacted the financial condition and results of operations? How do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition?  Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
• How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook? How is your overall liquidity position and outlook evolving? To the extent revenues have been impacted, how has that affected sources and uses of funds?  How have assumptions about the magnitude and duration of Covid and its impact on revenues and liquidity changed over time?
• Consider if the cost of or access to capital and funding sources has changed and whether it is likely to change or continue to change. Have sources and uses of cash been materially impacted?  Has the ability to continue to meet ongoing credit agreements changed, or is it materially likely it will change? How has a change, or a potential change, to your credit rating impacted your ability to access funding? Disclosure should also be made as to the course of action a company has taken or proposes to take in light of the material impact on its financial resources.
• Have you accessed revolving lines of credit or raised capital in the public or private markets to address your liquidity needs? Are you at material risk of not meeting covenants in your credit and other agreements? Are your disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of your financial condition and liquidity?
• 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? Have you provided additional collateral, guarantees, or equity to obtain funding?
• Are you able to timely service your debt and other obligations? Have you taken advantage of available payment deferrals, forbearance periods, or other concessions? What are those concessions and how long will they last? Do you foresee any liquidity challenges once those accommodations end?
• Are you adequately describing metrics and assumptions, such as cash burn rates?
• 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? Did you provide concessions or modify terms of arrangements as a landlord or lender that will have a material impact?
• 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? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and if so, how?
• Have you considered all subsequent events between the end of the financial reporting period and the date the report is filed with the SEC?
• How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets?  For example, will there be significant changes in judgments in determining the fair value of assets measured in accordance with U.S GAAP or IFRS?
• Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
• Have you reduced your capital expenditures and if so, how? Have you reduced or suspended share repurchase programs or dividend payments? Have you ceased any material business operations or disposed of a material asset or line of business?

Items that were listed in Topic 9, but that should still be considered, include:

• Have COVID-19-related circumstances such as remote work arrangements adversely affected your ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures?  If so, what changes in your controls have occurred during the current period that materially affect or are reasonably likely to materially affect your internal control over financial reporting?  What challenges do you anticipate in your ability to maintain these systems and controls?
• Have you experienced challenges in implementing your business continuity plans or do you foresee requiring material expenditures to do so?
• Do you expect COVID-19 to materially affect the demand for your products or services?
• Do you anticipate a material adverse impact of COVID-19 on your supply chain or the methods used to distribute your products or services?
• Will your operations or have they been materially impacted by any constraints or other impacts on your human capital resources and productivity? Have you materially reduced or increased your human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long do you expect to maintain them?
• Are travel restrictions and border closures expected to have a material impact on your ability to operate and achieve your business goals?

Specifically related to the CARES Act, companies should consider the short and loan term impact of any assistance received on their financial condition, results of operations, liquidity, and capital resources, as well as the related disclosures and critical accounting estimates and assumptions.  Specific items to consider include:

• How does a loan impact your financial condition, liquidity and capital resources? What are the material terms and conditions of any assistance you received, and do you anticipate being able to comply with them? Do those terms and conditions limit your ability to seek other sources of financing or affect your cost of capital? Do you reasonably expect restrictions, such as maintaining certain employment levels, to have a material impact on your revenues or income from continuing operations? Once any such restrictions lapse, do you expect to change your operations in a material way?
• Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity? Do you expect a material tax refund for prior periods?
• Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate? What accounting estimates were made, such as the probability a loan will be forgiven, and what uncertainties are involved in applying the related accounting guidance?

Related to a company’s ability to continue as a going concern, in addition to the points made in the OCA statement, Topic 9A suggests considering:

• Are there conditions and events that give rise to the substantial doubt about the company’s ability to continue as a going concern? For example, have you defaulted on outstanding obligations? Have you faced labor challenges or a work stoppage?
• What are your plans to address these challenges? Have you implemented any portion of those plans?

Not reiterated in Topic 9A, but still relevant, is the SEC’s notes in Topic 9, including that forward-looking information will be protected under either Sections 27A and 21E of the Private Securities Litigation Reform Act of 1995 (PSLRA) or the common law bespeaks caution doctrine as long as proper disclaimers are included (for more information, see HERE).

In addition to other considerations, the SEC companies should be cognizant of their obligations under Item 10 of Regulation S-K and Regulation G related to the presentation of non-GAAP financial measures.   The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and Item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, and the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.  For more on Item 10 and Regulation G, see HERE.