2020 has been a craptastic year for most people in some way. Many companies were significantly adversely impacted by the economic fallout due to COVID-19, and yet others saw their business go through unprecedented growth. We all look forward to wrapping up this year and moving on, but you have a few areas to focus on before 2020 comes to a close.
Accounting and Reporting Considerations
Impairment tests. Impairment tests for long-lived assets, intangibles and goodwill are based on forward-looking cash flow projections. It’s always been a challenge to see what’s going to happen, but the view is even foggier: There is a lot of uncertainty around COVID-19’s impacts: How bad will this get? How long will it last? When will things recover? And nobody has the answers. In the meantime, impacts to your supply chain, customer demand, ability to collect receivables, and so much more, should all factor into your projections.
Our best advice:
- Develop a flexible framework. Make it so you can easily update modeling for changes in assumptions and perform sensitivity analyses. As always, document your assumptions and keep good records of how you came to your decisions.
- Start a dialogue with your auditors. It’s a good time to check in. Get ahead of any issues that may arise, so you can avoid 11th-hour surprises as the audit process gets underway, particularly with respect to your assumptions.
Don’t forget: The accounting guidance for impairment requires you to evaluate assets in a particular order. For more about this and the other issues that auditors will be closely reviewing, see “Time for a Checkup: How COVID-19 Can Affect Your Financial Statements?.”
Debt. Any forgiveness or restructuring requires scrutiny for appropriate accounting treatment.
Lease agreements. Have you recently had lease modifications? If so, you weren’t alone—many companies renegotiated lease terms and were granted concessions by their landlords. That raised a lot of accounting questions, and the FASB responded with a Q&A document to help clarify how to apply the lease accounting guidance for concessions related to the pandemic .
Companies finding themselves with excess space may need to update assumptions used in their impairment analysis, as demand for office space in many locations has plummeted and finding a subtenant may not be feasible.
Equity awards. Did you make any modifications to incent employees whose compensation was adversely impacted by market price declines or missed performance goals? Remember to update your accounting for this, too.
Reductions in force (RIF). If you’ve gone through a RIF or have excess manufacturing capacity, remember to reassess costs capitalized to inventory, including overhead allocations. Declining demand or prices for your company’s products may signal the need for potential write-downs for excess inventory and valuation at lower of cost or market.
Another potential accounting effect of a RIF is on assumptions you are using for the expected term on your equity awards—this may need another look as well.
Revenue recognition. You’ll need to update your estimates for variable consideration. Did you modify any customer contracts, such as granting extended payment terms or other concessions? Check to be sure you have applied the appropriate accounting guidance.
Watch our associated Impairment Tests video, in which finance and accounting consultant Mary Castellucci shares some examples of impairment considerations for right-of-use (ROU) assets and the importance of building a flexible model.
Going concern evaluation. This may have been a relatively easy task for your team in the past, but due to the economy falling off a cliff this year, you likely have a less straightforward task ahead of you. Remember the timeframe—you need to assess the ability to continue as a going concern for 12 months from the date of issuance of your financial statements. In thinking about your ability to generate sufficient cash to finance your company during this assessment period, consider the extent of operational disruption, such as:
- Diminished demand for product/services
- Ability to manage expenses
- Access to existing sources of capital, such as lines of credit
- Temporary closure of your facilities (whether due to government action, such as shelter-in-place mandates, or a management decision)
- Disruption to supply chains causing delays or an inability to obtain product
- Increased interest expense due to higher debt levels
- Incremental debt at higher interest rates
- Workforce disruptions
Also think about potential noncompliance with debt covenants and whether that will accelerate due dates or result in restrictions on future borrowings—and put a squeeze on your working capital.
As with impairment testing, we recommend building a flexible framework for your assessment that you can update for changes in assumptions and to perform sensitivity analyses (also be sure to gather supporting documentation for your assumptions). You will want your operations people involved so that your finance team is armed with the best understanding of your business and cash flow as they assess the assumptions and sensitivities used.
Watch our associated Going Concern video, in which RoseRyan consultant Vicki Velez discusses how best to tackle your going concern assessment.
PPP Loan Forgiveness and Accounting Issues
No discussion about 2020 would be complete without a discussion about PPP loans. As of August, 5 million SBA loans totaling $525 billion were approved under the Paycheck Protection Program, but uncertainty lingers as companies seek 100% forgiveness.
Forgiveness timing. When should you file for forgiveness? While the intent was for the loan forgiveness to be a nontaxable event, the IRS published Notice 2020-32 stating that expenses related to loan forgiveness are not deductible, which in effect made the loan taxable for a number of companies. This was further reinforced in November when the IRS published Revenue Ruling 2020-27 indicating that it doesn’t matter if a taxpayer applies for forgiveness in 2020, or waits until 2021, since the amount is foreseeable in both situations. Therefore, taxpayers can’t deduct the expenses on their 2020 tax return. Revenue Procedure 2020-51 provides a safe harbor for deductibility of these expenses in 2020; however, the company will need to represent and disclose in the 2020 return that the forgiveness was denied or that the company decided not to request forgiveness of the loan.
Members of Congress, the AICPA, practitioners and taxpayers have requested that the IRS change its position regarding the deductibility of these expenses. At this point, it will take an act of Congress to make the change. Lawmakers have said that they are working to include legislation that taxpayers qualify for expense deductions even if their loans are forgiven. This could be included in government spending legislation that Congress must pass by December 11th.
There are now multiple forms available for taxpayers to request forgiveness. Companies should review the forms to determine which one is applicable to them.
Accounting. Another consideration is how to classify the PPP loan on your balance sheet. There is no specific authoritative guidance for this, so you’ll need to analogize—the most appropriate method for accounting for PPP forgivable loans is to follow the guidance under FASB ASC 405‐20 Liabilities: Extinguishment of Liabilities. You would record the loan as debt, and record the extinguishment of the debt when forgiveness of the loan is officially provided by the lender.
Watch our associated PPP Loan Forgiveness and Accounting video, in which RoseRyan’s founder and chair, Kathy Ryan, answers some frequently asked questions about several sometimes contradictory-seeming PPP loan forgiveness and accounting issues.
Changes in the economy and changes in how (and where) work gets done mean you have new considerations as you look at your internal controls and how you attest to them:
Materiality and risk assessments. Be sure to address risks related to external events and their impact on your business. Update your materiality assessment as you have more data—assumptions made earlier in the year may no longer be valid.
Review of control activities. What changed as a result of becoming a virtual workforce? Yes, ideally this would have been addressed back in March when these changes occurred, but if you haven’t, then now is the time.
- How are review controls being documented? For manual review processes—not everyone has access to a printer/scanner—if you’ve changed from documenting reviews through manual signature, tick marks and review notes, what evidence are you retaining to show how and when these reviews were performed?
- Have work duties been reallocated (either because of a RIF or to accommodate different physical location, or for other reasons) that may have segregation of duties implications? Is additional oversight or review controls needed to mitigate this issue?
- Is different system access needed to accommodate reallocation of work duties? Is the access properly approved? (And if the provisional access is no longer needed, did you remember to remove the access?)
- Did you update your documentation of controls? You may have made a number of changes in how your controls operate—did you update your process narratives, flow charts and control matrices to reflect the changes (e.g., to reflect what evidence you have to verify the control was performed)?
- Have you reviewed your design of controls where areas of judgment are involved? This will be especially scrutinized by the auditors. Methodologies and assumptions used in prior years may be insufficient this year. Be sure your control design includes robust and supportable back-up as part of the evidence of review and approval. Pay particular attention to estimates and reserves, impairment analysis, and renegotiations of debt and leases, to name a few.
Whether your business experienced big ups or downs this year, 2020 has been a year like no other. And so will be some of the considerations you’ll make as you prepare for the moment we can officially close the door on this period in time. Overwhelmed? Feeling uncertain? Our ‘Checklist for a Smooth Year-End Close’ will get you through it. And finance and accounting experts can help guide you through the uncharted weeks ahead, to prepare your company for 2021.