The coronavirus pandemic has the potential to create significant changes for CPAs who prepare company financial statements — and for auditors as well.
In the face of disruptions to global supply chains and other business activity, the SEC and the PCAOB in mid-February issued limited guidance to public companies and auditors for how they should manage their response to the pandemic.
“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,” the regulators said.
On March 4, the SEC issued a temporary exemption from meeting deadlines that fall between March 1 and April 30 for filing annual reports, proxy statements, and other regulatory documents. Companies have to explain why they need the exemption, which extended the deadlines 45 days, and refer to the SEC order in their public statements.
Fieldwork could pose a particular problem for auditors. The regulators expressed concern that auditors may have difficulty gaining access to the evidence and people they need to support their audit opinion. The most immediate effect the regulators raised in the statement concerned the disclosures mandated by FASB Accounting Standards Codification (ASC) Topic 855, Subsequent Events.
For the time being, the Center for Audit Quality (CAQ), which is affiliated with the AICPA, is advising practitioners to monitor regulators’ statements closely and keep them in mind when planning audits and carrying out their audit and review procedures.
“In keeping with recommendations from the Securities and Exchange Commission, audit firms are working in close collaboration with public companies’ audit committees and management to help ensure financial reporting and auditing processes remain robust and as timely as possible amid the global coronavirus crisis,” the CAQ said in a statement. “Audit firms are committed to maintaining high standards of audit quality as they serve their audit clients during this crisis while supporting the health and safety of their employees. The audit profession will remain in close contact with regulators as the impact of the virus on companies, auditors, and the audit process continues to be assessed.”
Some in the accounting community say the March quarter’s financial statements will provide evidence of the outbreak’s financial effects. These experts recommend that finance personnel and practitioners take the following steps.
Consider the epidemic as part of audit planning meetings. Andrew Imdieke, an assistant professor at the University of Notre Dame’s Mendoza College of Business, said he expects that accounting firms are already implementing contingency plans for how the epidemic may affect their audits.
“If you have a team of 10 people that are typically in the field for a particular client, you have to start thinking what if this all of a sudden spreads throughout an office or throughout a client, and you don’t have the people to do the work,” Imdieke said. “That’s just within the firm — the resource constraints they might face in the planning process.”
The planning sessions are also going to have to weigh how the client has been affected, not just in terms of its business operations and key accounts, but whether its staff is available to meet with auditors and/or whether its offices and facilities have been padlocked. In addition, travel restrictions might prevent visiting the client.
Be alert to the effect on many financial statement accounts. PwC LLP issued a statement on its website that said revenue estimates involving variable consideration and for other amounts customers pay may be affected. The firm also said a range of other accounts are subject to considerable change, including impairments to goodwill and other intangible assets, and stock compensation. PwC anticipates some effects for hedging contracts for forecasted cash flow, and it advises that depreciation expenses for idled facilities should still be recognized.
Regarding hedge accounting, PwC said, “Any derivative gains or losses deferred in accumulated other comprehensive income (AOCI) prior to the change in likelihood will remain in AOCI until the forecasted transaction impacts earnings (or until the forecasted transaction becomes probable of not occurring). If a company determines that the hedged forecasted transaction is probable of not occurring by the end of the originally specified time period (or within an additional two-month window thereafter), amounts deferred in AOCI are required to be recognized in earnings immediately.”
Be prepared to write down assets and make detailed disclosures about the pandemic’s effects. Wall Street’s decline into a bear market and the severe disruption that is rapidly unfolding for many business activities are certain to have a profound effect on March quarter results at many companies. The companies that believe their operations are being hurt may have to seriously consider making asset impairments and including detailed disclosures in the notes to their financial statements about their reduced revenue and earnings forecasts. The SEC and PCAOB’s February statement reminded public companies and their auditors “to consider potential disclosure of subsequent events in the notes to the financial statements” for year-end 2019 financial statements. Because the financial fallout is likely to worsen for March quarter financial statements, companies can be expected to continue making footnote disclosures about the pandemic’s effects during upcoming reporting periods.
“Those impairments will come with a great deal of testing, a great deal of disclosure,” said Michael Stevenson, CPA, the national practice leader — Accounting & Reporting Advisory Services group for BDO USA LLP in Dallas. “But what that looks like at this point is probably unknown.”
Expect client estimates to be more of a challenge than usual. Accounting estimates have long been among the more complex tasks for auditors.
Because of the extensive and unpredictable nature of the coronavirus epidemic, auditors can expect that their assessments of clients’ accounting estimates will be even more complicated than usual in upcoming reporting periods. Auditors have been quick to recognize that many significant accounts, including sales, inventory, and bad debt expenses, will be affected, as will normal business activities such as production and distribution.
“From the audit perspective, they need to really carefully look at those areas where management has discretion,” said Amal Shehata, CPA, an accounting clinical associate professor at New York University’s Leonard N. Stern School of Business. “Those are amounts that have to be estimated, and so evaluating how their clients are applying discretion is going to be critical. Despite all the technological tools we have at our disposal, there’s still a very human element to the audit process.”
Face-to-face meetings with clients remain an essential part of the audit process. Potential travel restrictions caused by the pandemic could make those in-person meetings difficult. Shehata said it may mean some modifications to normal audit procedures.
To the extent that travel restrictions prevent auditors from visiting client sites, auditors may have to disclose scope limitations to their normal procedures.
Be alert to the effect on employees and other stakeholders. Deloitte Touche Tohmatsu Ltd. published a statement on its website that advised clients to conduct thorough examinations of their operations and to be aggressive in making sure that their lines of communication remain open with employees, suppliers, and other important stakeholders.
Carefully consider internal controls. Employee illnesses and office closures may lead to the breakdown of internal controls. According to a Deloitte financial reporting alert, management may need to implement alternative controls if the controls that are in place are not effective.
Pay attention to loan covenants and lender requirements. Clients that were financially healthy entering 2020 may have found themselves with cash shortfalls by February. That’s going to affect how auditors examine their financial information, particularly with outstanding loans and debt covenants from lenders.
“As auditors, one area where we may need to pay more attention is whether clients remain in compliance with relevant debt covenant requirements,” Imdieke said. “If they’re not, the client might have to go back to the banks and either amend or obtain a waiver for that covenant to make sure that they’re in compliance.”
Prepare for an increase in going concern disclosures. With so much business activity squeezed and substantial doubt about when business will resume something of a normal pattern, companies that had problems may face a struggle to survive.
“They’re going to be dealing with going concern issues and how to evaluate them” for clients that are suffering from cash shortfalls, said Mihir Mehta, an accounting professor with the University of Michigan’s Ross School of Business. “That’s something that’s going to be quite prevalent.”
For more news and reporting on the coronavirus and how CPAs can handle challenges related to the outbreak, visit the JofA’s coronavirus resources page.
— Joseph Radigan is a financial writer based in New York. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA’s editorial director, at Kenneth.Tysiac@aicpa-cima.com.