6 Ways the COVID-19 Pandemic Could

Affect Financial Reporting for

Operating Companies – April 03, 2020

The coronavirus (COVID-19) pandemic has rightly become the focus of massive public attention in recent
weeks. In addition to concerns about the health of their workers, businesses are increasingly concerned about
how it will affect their financial results and the performance of their supply chain partners.

Though the full effects of the COVID-19 outbreak are yet unknown, the impact is already global. Every
business is affected in some way. As the outbreak continues to grow worldwide, U.S. companies, large and
small, are devising contingency plans and reworking their goals and budgets to address potential risks.
Likewise, investors and other stakeholders want to know how companies are responding to this emerging risk
factor.

Rules for Financial Reporting

The outbreak has coincided with the deadline for calendar-year entities to prepare and file their annual reports.
So how (and when) should companies report the effects on their financial statements? Disclosure requirements
largely depend on materiality — and whether failure to disclose this risk factor would make the financial
statements misleading to investors.

Accounting Standards Codification (ASC) Topic 855, Subsequent Events, requires companies that follow U.S.
Generally Accepted Accounting Principles (GAAP) to disclose events or transactions that occur after the
balance sheet date but before financial statements are issued (or available to be issued).
Under GAAP, there are two types of subsequent events:

1. Recognized Subsequent Events

These events provide additional evidence about conditions that existed at the date of the balance sheet and
affect the estimates inherent in the process of preparing financial statements.

2. Unrecognized Subsequent Events

These provide evidence about conditions that didn’t exist at the date of the balance sheet being reported on but
arose after that date.

Moreover, ASC Topic 450, Contingencies, outlines the accounting and disclosure requirements for loss and
gain contingencies. For example, this standard requires companies to accrue for potential lawsuits based on
the probability that a claim will be made and loss will be incurred.

Factoring COVID-19-Related Risks into Financial Statements

Under GAAP, U.S. companies may be required to factor COVID-19-related risks into their financial statements.
Examples of balance sheet accounts that may be materially affected by the outbreak include:

1. Financial Assets
Companies should consider the potential for impairment, as well as the need to adjust cash flow projections
and other assumptions used to measure non-quoted financial instruments. Financial assets reported at fair
value on the balance sheet may result in realized and unrealized losses.

2. Receivables
Customers adversely affected by the outbreak may be unable to pay outstanding invoices. This situation could
result in additional credit and liquidity risks, higher than usual bad debt, and even impairments and write-offs.
Cash flows from operations may also be affected.

3. Inventory
The outbreak may disrupt supply chains and productivity. Companies with reduced or idle production capacity
may be unable to allocate overhead costs to inventory as they usually do. In addition, inventory that can’t be
turned over because of travel restrictions may have to be evaluated for impairment. Finally, changes in prices
and reduction in the level of demand will also have to be taken into consideration.

4. Pensions and Post-Retirement Plans

Financial market volatility has affected the measurement of these accounts. Companies may have to revisit
both the expected return on plan assets and the funded status of the plans.

5. Deferred Tax Assets

If estimates of earnings of foreign subsidiaries change, companies may have to reconsider some of their tax
strategies, or they may not be able to realize all deferred tax assets.

6. Goodwill and Other Indefinite-Lived Intangible Assets

Subsidiaries in areas heavily affected by COVID-19 may see their revenues or net income affected by the
outbreak. This may trigger impairment testing for goodwill and other intangibles. The reassessment of key
accounting estimates and projections may result in an immediate impairment. Additionally, impairment testing
may have to be done more than once this year if management considers that evolving circumstances result in
more than one triggering event.

SEC Urges Public Companies to Provide Robust Coronavirus Disclosures

In February, as coronavirus (COVID-19) was already rapidly spreading and starting to adversely impact
businesses worldwide, SEC Chairman Jay Clayton issued a statement emphasizing the need for public
companies to consider providing subsequent event disclosures to investors.

Currently, most calendar year-end public companies are starting to file their Form 10-Ks. Clayton advised
companies that haven’t already filed their annual reports to look at their risk disclosures more closely. However,
he admitted that estimating the financial effects of the outbreak is challenging because COVID-19 and its
impact on the market continue to be uncertain.

“This remains a dynamic situation where the effects on any particular company may be difficult to assess or
predict, because actual effects may depend on factors beyond the control and knowledge of issuers. However,
how issuers plan and respond to the events as they unfold can be material to an investment decision, and we
urge issuers to work with their audit committees and auditors to ensure that their financial reporting, auditing
and review processes are as robust as practicable in light of the circumstances in meeting the applicable
requirements,” said a recent SEC statement.

On March 4, the SEC announced that it is granting public companies extra time to file certain reports because
of COVID-19. “The impacts of the coronavirus may present challenges for certain companies that are required
to provide information to trading markets, shareholders, and the SEC. These companies may include U.S.
companies located in the affected areas, as well as companies with operations in those regions,” said the SEC.

Clayton reminded all companies to disclose information about their assessment of risks related to the outbreak
“to the fullest extent practicable” to keep investors informed. He added, “Companies providing forward-looking
information in an effort to keep investors informed about material developments, including known trends or
uncertainties regarding coronavirus, can take steps to avail themselves of the safe harbor in Section 21E of the
Exchange Act for forward-looking statements.” Safe harbor means that companies won’t be held liable for the
statements.
Transparency about the nature of the event and management’s response to the outbreak is key. Public
companies that fail to provide robust disclosures about this risk factor or recognize its impact on operations
may receive comment letters from the SEC and potentially face additional actions from investors.

Whether you are a public or private company, there are many unknowns about the severity and duration of the
COVID-19 pandemic. Disclosing and recognizing its financial effects may require management to exercise
significant judgment and to work even more closely with its outside accountants.