By Calvin Rowland, Assurance Partner, HoganTaylor LLP
Many small and mid-size companies and nonprofit organizations are in financial reporting purgatory. They have not yet issued their December 31 year-end financial statements but live in a world that is completely different and significantly more uncertain than the one that existed as recently as February 1, 2020. If this is your company, you may be asking what does all of this mean to the reported balances and disclosures in the financial statements?
The is no universal pandemic accounting standard that answers this question.
The COVID-19 pandemic is a global event but its impact on financial statements is specific to the facts and circumstances of each company. Fortunately, while what we are experiencing is new and uncertain, the relevant accounting standards are old and familiar. Let’s revisit a few of them:
For your company, it all starts here. The pandemic is not a singular subsequent event. A multitude of things have happened in 2020 as a result of the spread of this disease. You should identify the specific events impacting your company.
Here are some examples to get you started:
- Stock market indexes crashed
- Oil prices dropped dramatically
- State and local governments ordered widespread non-essential business shutdowns
- The pandemic disrupted international supply chains
- You may have drawn down on your line of credit to maintain liquidity
Once you have identified the most significant impacts on your business, classify them between the two types of subsequent events identified in the accounting literature:
- Type 1 – Recognized events provide additional evidence about conditions that existed at the date of the balance sheet. These are the type of events that change numbers on the financial statements.
- Type 2 – Unrecognized events provide evidence about conditions that did not exist at the date of the balance sheet. If necessary to keep the financial statements from being misleading, you must disclose:
- The nature of the event
- An estimate of its financial effect, or a statement that such an estimate cannot be made
It can be difficult to distinguish between the two types. Here are contrasting examples of outstanding receivables with a customer that declares bankruptcy after year-end:
- Customer A has had financial difficulties for several years. While the pandemic was a contributing factor, the bankruptcy represents the culmination of conditions that existed before year-end. This is a Type 1 event and should be considered in establishing the allowance for doubtful accounts.
- Customer B’s business was extremely sensitive to the events related to the pandemic and previously had no financial difficulties. Its bankruptcy is a Type 2 event not impacting the allowance for doubtful accounts. It should be disclosed if the outstanding receivable balance is significant to financial statements.
Because the root cause was an unpredictable natural hazard, pandemic related Type 1 events for December 31 financial statements will be rarer than Type 2 events.
Risk and Uncertainties
The objective of this accounting standard helps financial statement users assess major risks and uncertainties that could impact your company in the near term (one year from financial issuance date). In practice, it often drives a lot of the generic disclosure including:
- Nature of operations
- Use of estimates in the preparation of the financial statements
- Significant estimates sensitive to change
Do your generic disclosures meet the objective considering the subsequent events? You don’t have to assume that financial statement users live under a rock.
For example, the AICPA Center for Plain English Accounting commented that specific disclosure on recent stock market volatility is not necessary if general disclosures related to market risks are already included in the footnotes. You also want to be sure that your disclosures are not so specific to current events that they become outdated soon after you issue the financial statements.
A loss contingency is an existing condition involving uncertainty as to possible loss that will be resolved when future events occur or fail to occur. Are any of your identified subsequent events loss contingencies?
You would evaluate for disclosure the same way as if they existed before year-end. If it is reasonably possible that a material loss has been incurred disclose:
- The nature of the contingency
- An estimate or range of the possible loss or range of loss or a statement that such an estimate cannot be made.
You would never record a liability for a loss contingency that occurred after December 31 (Type 2 event) but consider if the event is evidence about loss contingencies that existed before year-end (Type 1 event).
You must evaluate the Company’s ability to continue as a going concern one year from the financial statement issuance date. Consequently, 2020 events are highly relevant to your annual evaluation.
Consider whether the assumptions you have used are still accurate considering the identified subsequent events.
Despite the unprecedented level of uncertainty you may be feeling about the future and how it will impact your business, the key accounting principles to guide you through your financial reporting decisions and disclosures have been in place for many years and should provide a solid roadmap for you to follow. We urge you to approach the process with great diligence. Support your positions and disclosures with written documentation, collaborate with professional peers, and revisit your decisions as events unfold and you move closer to finalizing your financial statements.