Just in time for the end of second quarter, the Securities and Exchange Commission has published another dollop of guidance about financial disclosures companies should keep in mind as they navigate Covid-19.
The statement came Tuesday from chief accountant Sagar Teotia. It’s the latest in a series of pronouncements SEC officials have made since early March to help corporate disclosure professionals understand what the SEC considers important during the crisis and what the agency would like to see from the filings you publish.
As a whole, however, the issues Teotia stressed this week aren’t much different than what he cited in a prior statement from April 3. Here are his top items of concern.
Significant Estimates and Judgments
Companies should “ensure that significant judgments and estimates are disclosed in a manner that is understandable and useful to investors.”
If you want an example of what that means in practice, consider the case of Carlisle Companies, a manufacturer with about $4.8 billion in annual sales. Last month Carlisle got a comment letter from the SEC asking the firm to supply more detail about its goodwill and intangible assets.
Carlisle had reported in Q1 that it had assessed those assets and decided that impairment of those assets wasn’t necessary, because their carrying values were still above book value. Fair enough, but the SEC wanted Carlisle to expound on how high above book value those assets were: either “substantially” above value, or expressed in percentage terms. (Hat tip to financial data firm Calcbench for noting this comment letter, by the way.)
Asset impairments stemming from Covid-19 can certainly be a significant judgment. So can allowances for accounts receivables, allowances for loan losses, the value of leased assets, and much more. The question is what you’ll need to say about your judgments on those items, to impart useful information to investors. “We think we’re good!” isn’t enough.
Teotia flagged both disclosure controls and procedures, which management is supposed to review every quarter; and internal controls over financial reporting, which management reviews at the end of each year. Here’s what Teotia had to say:
We understand preparers have adapted, or are adapting, their financial reporting processes as they respond 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… We remind preparers that if any change materially affects, or is reasonably likely to materially affect, an entity’s ICFR, such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred.
Translation: yes, your financial processes may have gone haywire thanks to Covid-19. Maybe legions of financial staff are working remotely and management sign-off of controls is dicey; maybe you’ve furloughed key staff and segregation of duties has become messy. Maybe both of those things have happened and nobody told you, and you’re busy documenting and testing controls that no longer exist in the real world.
Teotia’s statement is diplomatically telegraphing the message that SOX compliance must still push forward. As it so happens, I recently wrote about Covid-19 and internal control challenges in a guest post for the Galvanize blog, if you want further thoughts on the subject.
Ability to Continue as Going Concern
Your company’s ability to continue as a going concern is always a big deal, and companies must assess every quarter whether business conditions are so dire that they raise “substantial doubt” about your ability to keep meeting business obligations over the coming 12 months.
The challenge now, of course, is that you have more business conditions to assess. Your suppliers might be facing their own liquidity or operational disruptions, that could also leave your ability to offer services in doubt. Your customer base might vanish. Either of those events might happen more quickly than anticipated, including within that 12-month time horizon the going concern assessment carries.
So what are companies supposed to disclose? Again, Teotia:
[D]isclosures 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 plans that alleviated substantial doubt. If after considering management’s plans substantial doubt about an entity’s ability to continue as a going concern is not alleviated, additional disclosure is required.
Also interesting here is that while Teotia and the SEC are leaning on companies to do better with disclosure, the PCAOB is leaning on external auditors to do better with their own assessments of clients’ ability to continue.
Auditors only have to express an opinion about a company’s ability to continue once a year, but if they find warning signs during their quarterly review of financial statements, they’re supposed to have that awkward conversation with the client (and the audit committee). So more of those awkward conversations may be happening this year than usual.
Other Emerging or Complex Issues
Teotia didn’t shed much light on what these emerging or complex issues might be, but did say that over the course of the Q1 reporting cycle numerous filers did consult with his office on questions about the CARES Act, debt modifications, hedging, lease concessions, revenue recognition, and more.
Then Teotia gave a plug for the Office of the Chief Accountant staff, who are available to help filers with particularly difficult questions. When in doubt, give them a call.