Secondary to the toll the coronavirus pandemic is having on people’s health and lives around the globe is its impact on companies. It’s forced companies to adapt quickly to shifts in supply, production and distribution, customer demand and workforce logistics while trying to plan for what’s next in the wake of uncertainty. On top of all that, they have much to consider as they begin to report their financial results for the first quarter of 2020, as the condition of the business has likely changed significantly. Companies not only need to assess the health of their financials, but they also need to document the process they use to perform this checkup as part of their disclosure controls and procedures.
When the auditors make their rounds (even if their rounds are performed through Zoom meetings and email), key vital signs they’ll be looking at include:
- Asset impairment
- Employee costs
- Revenue assumptions
- Company debt
Asset Impairment
Companies need to determine whether the disruptions in their business are short term in nature or whether they represent longer-term impairment indicators. In either case, documentation surrounding the company’s assessment as of each reporting period is important. As you consider the assets on your balance sheet and begin analyzing them for impairment, keep in mind that the accounting guidance requires you to evaluate assets in a particular order:
1. Accounts receivable, inventory and other assets: Companies that have adopted the new credit standard (ASC 326) should consider the COVID-19 pandemic when assessing their forecast of future economic conditions. For companies that have not yet adopted the standard, historical credit quality and experience may be less of an indicator of collectability and additional focus will be needed on the current economic environment.
Companies also need to assess the carrying value of their inventories, both in terms of inventory reserves based on diminished customer demand and in terms of their costing methodologies. The global pandemic has created labor and material shortages and has even shut down factories; however excess capacity costs should be expensed in the period incurred and not allocated to inventories as overhead. Other assets to consider when evaluating impairment might include prepaid expenses and equity method investments.
2. Indefinite-lived intangible assets (other than goodwill): These are intangibles not subject to amortization and may include trade names or in-process R&D work that has not yet been completed. Factors that may impact the fair value of these intangibles include changes in an entity’s cost factors, declines in revenues or cash flows, industry and market considerations and general macroeconomic conditions, including access to capital, fluctuation in exchange rates or other developments in the capital markets that could significantly impact the fair value of the indefinite-lived intangible.
3. Long-lived assets: Property and equipment, software development costs and intangible assets subject to amortization should be tested for recoverability when events or changes in circumstances indicate the asset’s carrying amount may not be recoverable. In light of the pandemic, factors to consider include changes in the extent or manner in which the asset is being used, a forecast that demonstrates continuing losses associated with the use of the asset or a current expectation that the long-lived asset will be sold or disposed of before the end of its useful life.
Before assessing long-lived assets for impairment, companies need to group their long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If your company has not had to evaluate long-lived assets for impairment before—and has not therefore gone through the exercise of assessing asset groups—plan ahead. This is a highly judgmental area and requires a careful look.
4. Goodwill: Even if it’s not time for your annual impairment test, an interim assessment may be warranted. Factors to consider include many of those noted above for long-lived assets and intangibles, but also could include changes in key personnel, strategy and customers. Wondering why measuring goodwill impairment is last on the list? Impairment of long-lived assets and intangibles may also impact the fair value of the reporting unit.
Employee Costs
Employee costs is a broad category, but in the midst of the pandemic, there are three important areas to pay attention to:
1. Restructuring costs: Employee severance costs representing a one-time benefit arrangement are recognized once management has approved a plan and it has been communicated to employees. Whether the termination requires the employee to stay beyond a minimum retention period will determine if you recognize such costs immediately or ratably over the remaining service period.
2. Contractual termination benefits: Companies may have contractual termination benefits that stem from executive employment agreements, benefit laws in a specific country or other means. Different from one-time benefit arrangements, contractual termination benefits are typically recognized when it becomes probable that the employee will be entitled to the benefits and an estimate can be made, even if employee communication hasn’t yet occurred.
3. Performance metrics: Performance targets are most commonly aligned with management and executive cash bonus programs and equity-based compensation. For cash bonuses, companies will want to assess their accrued compensation benefits and revise forecasts for future expense recognition. For equity awards with performance-based vesting, reevaluate the estimated quantity of awards for which it is probable that the performance conditions will be achieved and adjust stock-based compensation cost accordingly.
For public companies, keep in mind that performance-based equity awards are considered contingently issuable shares when computing diluted EPS. You will need to assess the number of shares that would be considered issuable if the end of the reporting period were the end of the contingency period.
Revenue Assumptions
Companies with revenue contracts that include variable consideration likely require a robust reassessment of their estimates based on the effects of the pandemic. ASC 606 requires companies to estimate the transaction price at contract inception, including variable consideration (e.g., volume discounts, rebates, returns, refunds, price concessions and royalties, to name a few). Variable consideration is included in the transaction only to the extent that it is probable the company won’t have a significant reversal of cumulative revenue recognition down the road as the uncertainties related to the variability resolve.
Estimates of variable consideration are required to be updated throughout the contract term to reflect conditions that exist at the end of each reporting period, which may include changes in customer demand (especially in the retail market), supply chain disruption, and impacts to manufacturing and distribution channels. Also, companies may be more likely to offer price concessions or increase existing ones to help drive demand.
In addition to reassessing estimates, factor in the possible deterioration in your customers’ ability to pay and the impact that may have on revenue recognition. To qualify as a “contract” under ASC 606, it must be probable that the company will collect substantially all of the consideration to which it’s entitled in exchange for the goods or services that will be transferred. If the collectability of the A/R balance is questionable, give additional thought as to whether revenue recognition on new transactions with that customer is appropriate.
Company Debt
The pandemic is creating significant and unexpected changes in the cash flows and results of operations for many entities. As a result, companies may find that they are not in compliance with some of their existing debt covenants. If the debt is callable upon a covenant violation, the company may need to reclassify the debt as current. Even if the company obtains a waiver for the current reporting period, if it is probable that the company will fail the covenants within one year from the reporting date, the debt would still be required to be classified as current.
As businesses consider modifications to their existing debt arrangements—whether to increase lending, extend payment terms or to change the debt covenants—they will need to assess whether the debt modification is viewed as a troubled debt restructuring, which dictates different accounting treatment than a standard modification.
As you go over the steps necessary to vet the wellness of your company’s financial statements, know that RoseRyan is standing ready to assist. Our team of finance and accounting experts can also help to assess whether additional review is needed based on your company’s specific financial picture.
Getting Through the Audit Storm: Five Ways to Prepare for Your Next Audit
By Pat Voll
No one likes surprises. Anyone who has gone through an audit can attest to this, from the auditors themselves to the CFOs prepping their company for their first-ever or umpteenth audit. We were fortunate to hear from both sides of the audit process during a recent RoseRyan-hosted webinar, “Zen and the Art of Audit Readiness“, featuring the perspectives of a CFO, an audit committee member, and an auditor. The speakers shared their top tips and observations from the many audits they’ve experienced over their careers. Here are just some of the most interesting takeaways from this event.
1. A fast-growing private company’s first audit is usually the toughest – but public companies struggle too.
No matter why you’re getting an audit – because it’s a regulatory requirement or a request by investors, acquirers, or some other party – the whole effort will hinge on how ready you are for the auditor’s scrutiny. If you’ve recently taken on a new system or a new accounting pronouncement; undergone a major transaction; or your finance team had major turnover in the past year; the decisions you made along the way may not mesh with the auditor’s expectations. Even a public company with tight, streamlined operations may get tripped up by a complicated accounting issue one year.
“I’ve seen some pretty messy public companies, and I’ve seen some pretty messy private companies,” said Benjamin Shappell, partner in audit services at RSM US LLP. “On the flipside, I’ve seen very well managed private companies where the audit is smooth and crisp.”
2. The audit process can make your books and records more functional.
Is the information you’re tracking and recording reliable? The audit may reveal problematic processes and systems that are preventing management from truly understanding the business: you may have been making decisions based on flawed financial information. But by the time the auditors weigh in, you may have lost out on valuable time.
“You should really address the operational issues as soon as possible because your management team will get more use out of the financial statements while you’re in the process of getting ready for your audit,” said Mike Ownby, CFO at Infoworks.io (and a RoseRyan alum).
3. The strengths and weaknesses of the team should be evaluated before the auditors arrive.
“It’s become evermore difficult to find the talent to make sure you can do the work,” said Dan Fairfax, a former CFO at Brocade Communications who is on the audit committees of Super Micro Computer and Energous Corp., and the board of Saama Technologies.
He suggested taking inventory of both technical accounting and operational accounting expertise you have in-house. Understand the gaps so you can take action for filling them in advance. This can be a formal, ongoing endeavor, involving a skills matrix and a process for keeping skills up-to-date through training and job rotations. Very likely, in the short term, outside expertise may be needed to get the books in order and properly prepare for the audit.
In fact, leaning on a third party to achieve “audit readiness” can save the company in terms of audit costs and time, according to Shappell. Otherwise – for problems that don’t get addressed – the company can get bogged down by the audit (problematic audits can last several months, even a year).
A lease issue or account reconciliation issue “can steal time from CFOs, from accounting teams, from sales teams, from development teams – all of the individuals across the business that can’t focus on what they do day-to-day because they’re focused on an issue that could have been resolved had it been prepared as part of the audit readiness process,” Shappell said.
4. Internal controls must be stable.
Ownby noted this is a particular challenge for rapidly growing private companies in Silicon Valley, but it’s a must for every company to understand the key processes and people they rely upon for producing financial results – and to know what areas need improvement, and to have proper documentation around all of it.
Even public companies may need to take another look at how they balance workloads to ensure they have proper segregation of duties and can show they do through proper documentation. Fairfax brought up the example of a public company in the pre-revenue, development stage, with a small finance team, that had to be particularly cognizant of this issue.
5. Communication and collaboration throughout the process will minimize the risk of surprises.
As early as you can, get a plan going with the audit firm, so you understand what they need and they can get to know your business. You may even learn a few things along the way. “My view is they can make me smarter because I only see what’s directly in front of me in terms of the company I’m working on,” Fairfax said. “I can get blinders on as I’m working on my business. So, I want them to broaden me, to make me aware of new things coming down the road.”
Some surprises are bound to creep up, whether you’re about to undergo your first-ever audit as a private company, or an audit after a challenging year as a public company. Indeed, the COVID-19 pandemic’s effect on your business could bring up some new accounting challenges (Shappell had some predictions on why some audits may be more expensive because of this turn of events). Every time, being as ready as possible for the auditors can ease the entire experience.
Would you be ready if an audit happened today? Listen to the replay of “Zen and the Art of Audit Readiness” for more practical tips and best practices for preparing your company. And download RoseRyan’s newest white paper, “A Better Audit Experience: Setting Up for a Smoother Process” to learn the three most common culprits to time-consuming audits and how to over come them.
Pat Voll is a vice president at RoseRyan, where she provides strategic guidance into several practice areas, including corporate governance, strategic projects and operational accounting. She also manages multiple client relationships, develops new solutions for the firm and oversees strategic and corporate culture programs. Pat previously held senior finance level positions at public companies and worked as an auditor with a Big 4 firm.
Interim Finance Consulting: Outsourced Financial Wisdom That Will Make All The Difference to Your Business
Entrusting your finance and accounting function to an interim consultant: we show you why it makes better business sense to hire a master trouble-shooter and adaptable multitasker to take your organization to the next level
Anytime someone in a vital finance role departs, whether it’s temporary or for good, a scramble begins for filling those deep shoes. But the work doesn’t stop. Someone needs to take over during this in-between time to keep things moving. It’s also a perfect opportunity to lift the team to a higher level of performance, gain a fresh perspective on what’s truly needed in the role, and bring insights and clarity to the processes and workflow needed to support your business. But how? This is when we’re often asked, “What does an interim consultant do?” and “Why hire a consulting firm rather than a temporary staffing agency?”
As a finance and accounting consulting firm made up of a range of committed pros who love the variety of companies and challenges that the consultant life provides, we know what we’d recommend. But we also know the distinction is not always clear to those who don’t live in our world. Oftentimes, a client doesn’t realize how wide of a gap their key employee left behind. We’ll find that they’re missing out on a detailed understanding of a system or process that no one else was keeping track of. Or shifting business priorities have taken the company in a new direction, and the skills on hand aren’t a full match for the higher complexities that lie ahead. It takes a particular kind of expertise to bridge such gaps. It requires a proactive nature, and the drive to make the company whole again before the interim finance engagement or project gets wrapped up.
In the following examples, our consultants – rather than someone working through a temp-to-perm firm – were the best fit for a particular situation. The work evolved as unexpected issues arose or things turned out to be more complicated than the client predicted.
1. An interim CFO provides stability when turmoil hits.
At first, RoseRyan interim CFO Joe Kontur spent three days a week overseeing the finances of a private community while the search for a full-time finance chief was underway. He quickly got in a groove with the accounting organization handling the community’s five corporate entities, including a golf club. The scope of his role soon changed, though, when the HR director and head of risk management left. With Joe already up to speed, the company had the support necessary – Joe has the experience to get the company through its annual open enrollment period and assist with selecting and on-boarding an outsourced HR firm.
In early March, the coronavirus pandemic shut nearly everything down in California. This put a halt to the private company’s recreational and dining activities, and threw all plans and forecasts into question. Even though Joe had only been around for about a month, he was ready to provide the finance leadership needed to help management adjust their priorities and outlook. His work sharply pivoted to what-if scenarios, financial modeling, loan evaluations, and cash flow analysis. Joe’s guidance provided stability in a very unstable environment. To find out how Joe navigated this client through troubled waters and put them back on course, click here.
2. An interim senior accountant adapts to any and every situation.
Consultants are known for becoming a part of the team, very quickly. They also become experts in areas of the company, sometimes even more than the people on staff. This is what happened when RoseRyan consultant Pierre Joudy was brought on as an interim senior accountant to backfill a senior accountant role and help the client catch up on backlogged account reconciliations for one of its subsidiaries. Due to high staff turnover, there was no single individual who had a good understanding of the workflow and systems used by this sub.
Working cross-functionally, Pierre learned the subsidiary’s legacy systems and accounting and operational processes. He took the extra step of offloading this knowledge by documenting processes and training the client’s team on best practices. In fact, he got to know so much about the subsidiary that the company heavily relied on Pierre for many other tasks that had languished. As the “resident expert,” he also became the primary contact for an important audit. Whatever came Pierre’s way, he was ready for it. Click here to find out more about how Pierre untangled the knots in this client’s financial affairs.
3. An interim cost accountant becomes a trusted advisor.
Finance consultants are highly adaptable – they’ve been in a variety of situations, at a variety of companies, and they bring a broad skill set to every job. Among other things, RoseRyan consultant Mary Castellucci is a master at cost accounting: the primary reason a publicly traded biopharmaceutical company reached out for our help when their cost accounting director left.
Mary worked closely with the company’s supply chain group to get through the year-end close – physical inventory counts, journal entries, account reconciliations, management reporting and disclosures, and standard cost updates, among other much-needed tasks. During the course of her work, Mary identified gaps and inefficiencies, and she recommended streamlined processes as well as changes in workflow. The ultimate goal? To make it so different functions could work more collaboratively. She also documented these new processes so that the work would be done right when it was time for her to move on. The new processes and information she laid out gave management a better understanding of their true needs for the role.
In the midst of this work, the client was acquired, resulting in turnover and additional responsibilities for Mary. Drawing on her own expertise, with input from the RoseRyan Technical Accounting Group, she considered the accounting implications of the changes in business operations on inventory valuation, and she worked with the acquiring company’s transition team to understand their reporting requirements and timetable. It was a tight schedule, and Mary worked collaboratively with the various people involved to successfully meet the new deadlines. When employees’ responsibilities shifted, Mary could help to fill the gaps and get the company through this transitional time. To discover how Mary passed on the baton to this client’s team and helped them to successfully reach the finish line, click here.
Why should you use an Interim Finance Advisory Solution?
What often happens when a company loses a senior employee or discovers a temporary need for a special skill is the initial ask doesn’t match what’s actually needed. Few people explain every little thing they do when they leave an employer. Something gets overlooked or forgotten. Institutional knowledge fades away with every departure. At the same time, the company keeps changing, and new challenges arise.
When you opt for a consulting firm to get you through the next hurdle or temporary bump in the road, you’re making an efficient choice, with experts who don’t need a lot of direction or ramp-up time, are able to pivot quickly when business needs change, can ascertain what is truly needed, and are focused solely on the business at hand. They’re driven by what they love to do – helping a company pick up the pieces, putting their finance and accounting expertise into action, uncovering trouble spots, and upskilling the rest of the team to make sure everything will run smoothly when they leave. They’re highly efficient, adaptable, and flexible to any scenario thrown their way.
Anticipate a big change? Has a skills gap opened up? Need finance and accounting guidance for an upcoming project? Contact RoseRyan to learn more about our Interim Finance Solutions, and check out more case studies on our Clients page.
To discover how RoseRyan Interim Finance can help you solve your company’s finance and accounting challenges, and to get a complimentary tailored needs assessment, click here
PPP Loans: Getting Through the Chaos of the Pandemic-Lending Program for Small Businesses
One thing is for sure with the Paycheck Protection Program (PPP): It’s been chaotic. The banks were overwhelmed with applications for the first round of $349 billion. A lack of clear information about the process and requirements led to mixed messages for the small businesses and startups that sought funding, along with long wait times and lots of frustration when the money dried up in just two weeks. And some large companies are finding out the hard way that they shouldn’t have applied for a PPP loan in the first place.
As companies apply for the second round of funding—an additional $310 billion was made available by Congress on April 24—for these SBA loans, some of the initial problems are getting ironed out, but questions persist. I’ve picked up on a lot of answers while helping clients determine their eligibility and loan amounts, comparing notes with my networking peers, and attending seminars on this topic (virtually of course).
In a recent virtual hours session for RoseRyan, I talked about how those companies that did manage to get over the application hurdle felt tremendous relief—one CEO I know said this financing will help save his business. It also comes with favorable terms as PPP loans are designed to help small businesses and nonprofits secure financing to help them survive the coronavirus-related mandated closures happening nationwide and prevent as many layoffs as possible. The terms include:
Best Practices for PPP Loans
Since this program is so new, the ideal approach for applying for and meeting the terms of a PPP loan will evolve, but as of today, these are the best practices I’ve found to be true:
Have a plan for how you’ll use the funds.
Everything is moving so quickly that your instinct may have been to apply for the loan and hope for the best. But this has put companies in the awkward position of not knowing what to do next. Should you start hiring back employees without knowing whether you’ll have to let some of them go in two months if the pandemic persists? Or what if you make a wrong move and put the forgiveness in jeopardy? Going over the options with outside experts who understand companies like yours and your exact situation can help you make the right decisions up-front and over the course of the loan period.
Document, document, document.
Keep good records throughout the application and use of funds process, from calculating your full-time-equivalent employees; documenting how you came up with your numbers; and tracking how the funds are used and how the forgiveness requirements are calculated.
Proceed with care.
While companies need to make a number of certifications when they apply for a PPP loan, two in particular have caused confusion and hand-wringing:
Apply and use as if you’ll be audited.
U.S. Treasury Secretary Steven Mnuchin has said PPP loans over $2 million will be subject to audits, but I think those who borrow less should be ready to face scrutiny, too. This is why all the documentation matters.
Open a new bank account.
Once you receive the loan, consider setting up a separate bank account. When it comes time to pay for eligible expenses, you can transfer the loan money to your operating banking account. This provides a clean separation for your new funding. Document these withdrawals and what they’re used for.
Pay careful attention to your expenses during the eight-week window.
While you’re probably being careful with costs right now anyway, create a budget of expected costs and then track accordingly. You want to make sure that you track and document all the eligible expenses to maximize loan forgiveness.
File for forgiveness quickly.
When the eight-week period ends, work directly with your lender to show them how you’ve met the forgiveness requirements. They have 60 days to notify you whether they agree, and will send you a letter of reprieve. Your accounting team should record the amount of forgiven debt under “other income” and not as operating income.
The PPP process has been incredibly quick and fluid, requiring companies to be patient as they await word about their application and further clarifications and guidance about the program. For instance, we know that the forgiveness amount will not be taxed by the IRS. However, despite the IRS’s stance that the expenses relating to the loan forgiveness will not be deductible, members of Congress have stated that this was not their intent and may pass legislation to counter the IRS’s position. It’s also not clear whether California will follow along with the federal law or whether the forgiveness will be taxed at the state level.
To keep on top of the details, lean on the expertise of those who have followed the details of the program since the beginning and fully know the unique needs of small businesses.
RoseRyan Chair and Founder Kathy Ryan guides the overall mission, strategy, direction and investment decisions of our finance and accounting consulting firm. She has been recognized as a thought leader and innovator, building upon her extensive CEO and CFO experience at her own firm and guiding a variety of Silicon Valley startups through various challenges and opportunities. As a consultant CFO, Kathy worked closely with companies applying for the first round of PPP funding before the program ran out of the initial $349 billion in 13 days.
Understanding the Coronavirus Pandemic’s Effect on the Economy
Amid all the uncertainties brought on by the coronavirus pandemic, the economic implications of the health crisis are becoming clearer by the day. During a special, RoseRyan-hosted virtual event last week, Dr. Jon Haveman, Executive Director of NEED (National Economic Education Delegation) and a frequent speaker on the U.S. economy, provided us with a valuable perspective on how the crisis is affecting GDP, the stock market and unemployment, and the fiscal policy moves that are helping to minimize the lasting effects of recent business shutdowns.
Haveman likened the pandemic to a natural disaster in terms of how to deal with it. Unlike, say a massive earthquake that affects just one metropolitan area, however, the pandemic is global, the duration is unpredictable, and “the economic toll is enormous and potentially durable if we don’t manage it quite right.”
The recently released estimate for Q1’s GDP was a shock, Haveman said (see above chart). GDP seasonally adjusted at an annualized rate suggests that if GDP continues growing at the same rate as last quarter, we will lose five percentage points in the course of the year, affecting the economy’s resiliency.
While the stock market tumbled earlier this year, the $2.2 trillion congressional virus relief package has aided an upward trajectory for now, said Haveman, whose nonprofit promotes a nonpartisan understanding of the economics of policy issues. Contrast NASDAQ’s performance today during the 2008 recession, when the government was much slower to respond to the mortgage crisis (see chart below).
Another tough figure to observe these days is unemployment. Between February and March, 700,000 jobs were lost, “a remarkable rate of decline,” Haveman noted. The next survey, to be released on Friday, will likely be in the millions.
When Will the Economy Bounce Back?
Haveman praised many of the actions taken so far to help flatten the curve through social distancing. By slowing the pace of COVID-19 infections, the crisis will take longer to get through but fewer people are likely to die and health care demand can be kept to a manageable level. “With protective measures, we get an almost immediate impact on the economy and the trough is much lower than it otherwise would be,” Haveman said. “We’re going to be in the soup of this for longer than if we had let it run its course, but this is an effort to save lives.”
As for how long we can expect to be in a recession and recovery phase, Haveman said a continuing decline in GDP is a given for the second quarter and likely for Q3 as well. But even when GDP begins to grow again, it will stay below where it otherwise would have been without this crisis—and that may last for as long as six quarters to two years.
As companies wait for when they can return to what feels like more normal workdays in the office, Haveman suggests retaining tight connections with current and furloughed employees so that you’re prepared to ramp up when the time comes. The future of the workplace and the demand for services may not be the same as it was for many companies at the start of 2020 anytime soon, but it’s always sound advice to prepare for what’s ahead.
To catch all of Haveman’s talk with RoseRyan, you can view the webinar and slides from RoseRyan’s Events page.
As CEO of RoseRyan, David Roberson leads the day-to-day business and builds upon the firm’s established reputation for taking companies further, faster. He also serves as CEO of Kukuza Associates, a RoseRyan subsidiary that provides accounting and finance services to cannabis companies. David previously served as a senior vice president for Hewlett-Packard Co.; president and CEO at Hitachi Data Systems, where he has previously held the titles of COO, CFO, CIO and general counsel; and he has served as a director of 12 companies including Brocade, Quantum, IGT, Spansion and IDT.
Investors Flood Life Sciences Companies Fighting COVID-19: What to Do Next
One of the coronavirus pandemic’s overriding messages is the need for speed. Companies rapidly switched gears to do their part in stemming the spread of the virus, and “non-essential” employees quickly adapted to working from home. For the life sciences companies that are developing new drugs or tests that can help save lives of those affected by COVID-19, they are up against an incredibly fast, pressure-filled clock.
Unlike other industries where funding has dried up, some life sciences companies are seeing an abundance of interest by venture capital firms and other investors to get their products market-ready as soon as possible, to ease COVID-19-related suffering or to help prevent more people from getting sick. While working toward meeting new, urgent deadlines, these companies need to be thoughtful and strategic about their spend, putting controls and processes in place to protect, record and track where the money is going. Under these situations, some areas of the business may not get the attention they require, so here are a few key actions to ready your life sciences company for the changes ahead:
Also look carefully at your supply chain, if you haven’t already, during this pandemic. Is it up and running, ready to support the company’s growing and, perhaps, changing needs? You must have resilient partners and backup if unexpected changes occur. For new suppliers, pay attention to creditworthiness to avoid joining up with a company that could be out of business tomorrow.
Life sciences companies fighting COVID-19 face both challenges and opportunities during this crisis. Expectations are high. Moving rapidly is a must. Aided by funding, life sciences companies can achieve great feats—but that funding needs to be applied with thoughtfulness, monitoring and proper controls. Finance pros who understand this market and the unique needs of these companies can help you meet those requirements so that everyone else in the company can focus on saving and protecting lives.
As CEO of RoseRyan, David Roberson leads the day-to-day business and builds upon the firm’s established reputation for taking companies further, faster. He also serves as CEO of Kukuza Associates, a RoseRyan subsidiary that provides accounting and finance services to cannabis companies. David previously served as a senior vice president for Hewlett-Packard Co.; president and CEO at Hitachi Data Systems, where he has previously held the titles of COO, CFO, CIO and general counsel; and he has served as a director of 12 companies including Brocade, Quantum, IGT, Spansion and IDT.
COVID-19 Pandemic and Getting Through It: Resources and Ideas for Startups Seeking SBA Loans
Venture-backed startups are used to running at a fast pace as they seek out growth opportunities and work toward making a foothold in the marketplace. But in the midst of the COVID-19 pandemic, the pace is more frantic than normal—and full of uncertainty.
Time for a Checkup: How COVID-19 Can Affect Your Financial Statements
Secondary to the toll the coronavirus pandemic is having on people’s health and lives around the globe is its impact on companies. It’s forced companies to adapt quickly to shifts in supply, production and distribution, customer demand and workforce logistics while trying to plan for what’s next in the wake of uncertainty. On top of all that, they have much to consider as they begin to report their financial results for the first quarter of 2020, as the condition of the business has likely changed significantly. Companies not only need to assess the health of their financials, but they also need to document the process they use to perform this checkup as part of their disclosure controls and procedures.
When the auditors make their rounds (even if their rounds are performed through Zoom meetings and email), key vital signs they’ll be looking at include:
Asset Impairment
Companies need to determine whether the disruptions in their business are short term in nature or whether they represent longer-term impairment indicators. In either case, documentation surrounding the company’s assessment as of each reporting period is important. As you consider the assets on your balance sheet and begin analyzing them for impairment, keep in mind that the accounting guidance requires you to evaluate assets in a particular order:
1. Accounts receivable, inventory and other assets: Companies that have adopted the new credit standard (ASC 326) should consider the COVID-19 pandemic when assessing their forecast of future economic conditions. For companies that have not yet adopted the standard, historical credit quality and experience may be less of an indicator of collectability and additional focus will be needed on the current economic environment.
Companies also need to assess the carrying value of their inventories, both in terms of inventory reserves based on diminished customer demand and in terms of their costing methodologies. The global pandemic has created labor and material shortages and has even shut down factories; however excess capacity costs should be expensed in the period incurred and not allocated to inventories as overhead. Other assets to consider when evaluating impairment might include prepaid expenses and equity method investments.
2. Indefinite-lived intangible assets (other than goodwill): These are intangibles not subject to amortization and may include trade names or in-process R&D work that has not yet been completed. Factors that may impact the fair value of these intangibles include changes in an entity’s cost factors, declines in revenues or cash flows, industry and market considerations and general macroeconomic conditions, including access to capital, fluctuation in exchange rates or other developments in the capital markets that could significantly impact the fair value of the indefinite-lived intangible.
3. Long-lived assets: Property and equipment, software development costs and intangible assets subject to amortization should be tested for recoverability when events or changes in circumstances indicate the asset’s carrying amount may not be recoverable. In light of the pandemic, factors to consider include changes in the extent or manner in which the asset is being used, a forecast that demonstrates continuing losses associated with the use of the asset or a current expectation that the long-lived asset will be sold or disposed of before the end of its useful life.
Before assessing long-lived assets for impairment, companies need to group their long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If your company has not had to evaluate long-lived assets for impairment before—and has not therefore gone through the exercise of assessing asset groups—plan ahead. This is a highly judgmental area and requires a careful look.
4. Goodwill: Even if it’s not time for your annual impairment test, an interim assessment may be warranted. Factors to consider include many of those noted above for long-lived assets and intangibles, but also could include changes in key personnel, strategy and customers. Wondering why measuring goodwill impairment is last on the list? Impairment of long-lived assets and intangibles may also impact the fair value of the reporting unit.
Employee Costs
Employee costs is a broad category, but in the midst of the pandemic, there are three important areas to pay attention to:
1. Restructuring costs: Employee severance costs representing a one-time benefit arrangement are recognized once management has approved a plan and it has been communicated to employees. Whether the termination requires the employee to stay beyond a minimum retention period will determine if you recognize such costs immediately or ratably over the remaining service period.
2. Contractual termination benefits: Companies may have contractual termination benefits that stem from executive employment agreements, benefit laws in a specific country or other means. Different from one-time benefit arrangements, contractual termination benefits are typically recognized when it becomes probable that the employee will be entitled to the benefits and an estimate can be made, even if employee communication hasn’t yet occurred.
3. Performance metrics: Performance targets are most commonly aligned with management and executive cash bonus programs and equity-based compensation. For cash bonuses, companies will want to assess their accrued compensation benefits and revise forecasts for future expense recognition. For equity awards with performance-based vesting, reevaluate the estimated quantity of awards for which it is probable that the performance conditions will be achieved and adjust stock-based compensation cost accordingly.
For public companies, keep in mind that performance-based equity awards are considered contingently issuable shares when computing diluted EPS. You will need to assess the number of shares that would be considered issuable if the end of the reporting period were the end of the contingency period.
Revenue Assumptions
Companies with revenue contracts that include variable consideration likely require a robust reassessment of their estimates based on the effects of the pandemic. ASC 606 requires companies to estimate the transaction price at contract inception, including variable consideration (e.g., volume discounts, rebates, returns, refunds, price concessions and royalties, to name a few). Variable consideration is included in the transaction only to the extent that it is probable the company won’t have a significant reversal of cumulative revenue recognition down the road as the uncertainties related to the variability resolve.
Estimates of variable consideration are required to be updated throughout the contract term to reflect conditions that exist at the end of each reporting period, which may include changes in customer demand (especially in the retail market), supply chain disruption, and impacts to manufacturing and distribution channels. Also, companies may be more likely to offer price concessions or increase existing ones to help drive demand.
In addition to reassessing estimates, factor in the possible deterioration in your customers’ ability to pay and the impact that may have on revenue recognition. To qualify as a “contract” under ASC 606, it must be probable that the company will collect substantially all of the consideration to which it’s entitled in exchange for the goods or services that will be transferred. If the collectability of the A/R balance is questionable, give additional thought as to whether revenue recognition on new transactions with that customer is appropriate.
Company Debt
The pandemic is creating significant and unexpected changes in the cash flows and results of operations for many entities. As a result, companies may find that they are not in compliance with some of their existing debt covenants. If the debt is callable upon a covenant violation, the company may need to reclassify the debt as current. Even if the company obtains a waiver for the current reporting period, if it is probable that the company will fail the covenants within one year from the reporting date, the debt would still be required to be classified as current.
As businesses consider modifications to their existing debt arrangements—whether to increase lending, extend payment terms or to change the debt covenants—they will need to assess whether the debt modification is viewed as a troubled debt restructuring, which dictates different accounting treatment than a standard modification.
As you go over the steps necessary to vet the wellness of your company’s financial statements, know that RoseRyan is standing ready to assist. Our team of finance and accounting experts can also help to assess whether additional review is needed based on your company’s specific financial picture.
What Financial Restatements Are All About: Get Through the Process with These Insights
Since financial restatements are pretty rare, your first inclination when faced with one could be panic. It’s an understandable reaction when restatements are often associated with occurrences of fraud (Enron’s and WorldCom’s infamous restatements come to mind). But not all restatements are caused by an unscrupulous executive’s desire to meet earnings expectations, increase stock prices or earn incentive compensation. Sometimes errors occur due to honest mistakes or misapplication of accounting guidance.
After all, accounting rules are complex (implementing the new standards for revenue recognition and lease accounting have been huge undertakings). Financing arrangements can be complicated, and determining the correct authoritative guidance can be tricky. And it’s subject to interpretation—and errors. If you suspect you may need a restatement, here’s how to get through your company through the restatement process, from figuring out if a restatement is necessary to determining how the problem happened, and correcting it.
1. Keep Calm
If you find you have an error in your prior period financial statements, don’t freak out. We get it—you probably don’t have a history of dealing with this type of issue, and remediating financial reporting issues can be a complex process. This would be a good time to reach out to experts who have taken companies through it and can help you. Don’t underestimate the work that’s ahead.
Don’t let your organization get distracted by the restatement process. It’s important for the company to stay the course, so you’ll want to minimize the disruption to other departments as much as possible. In our experience, the companies that come out of a restatement successfully are the ones that continue to focus on their core operations and revenue growth. Investors could see the underlying business was strong. As for the finance organization, you’ll likely need extra help to handle the day-to-day accounting so that nothing falls behind. Don’t underestimate the workload involved in this process!
2. Investigate the Error
When an error is discovered in a previously issued financial statement, it needs a close look. Assess whether it is material—this assessment should include both quantitative and qualitative factors (e.g., even a small error could mask the full picture of what’s going in the business, such as trends in revenue or earnings or the company’s ability to meet its debt covenants). If you determine the error is material to the prior period, you are looking at a restatement, and you will need to notify your investors in an 8-K which of your previously issued reports should not be relied upon.
How and what you communicate is important—you want to provide the necessary information without causing your investors to question whether your future financials will be reliable. As you get through the process and understand more fully what caused the error, your investors will make decisions about the seriousness of the error, how much of an impact it is likely to have, and whether this was an innocent mistake or something more sinister.
3. Dig Deeper
Your investigation should assess why the error occurred—was this an intentional misrepresentation of the financial statements in order to meet revenue expectations, boost the stock price or meet executive bonus plans? Is the error limited to a single transaction, or is it more pervasive? Was an individual performing tasks they were not qualified to do? Was the company relying on inaccurate underlying data to record transactions?
Your course of action will depend on what your root cause investigation reveals. You may need to look at all transactions handled by a specific individual or all areas involving significant judgments. Or if this issue was related to inaccurate data, you will be looking at data sources and reconciliation processes across the board to ensure that all other data sources are complete and accurate. In any event, you will need to review all areas of potential risk, not just the transaction in question.
4. Create a Plan, and Put the Right Team in Place
With a lot to review and the need to be meticulous, a project plan will help lead the way. This plan should clearly identify roles and responsibilities, including a strong project manager to lead the team. This person will need to manage expectations of all key stakeholders (internal and external) throughout the process. You likely will need people with strong technical accounting skills to review your significant transactions and ensure they were recorded properly, have the appropriate supporting documentation and are ready to stand up to the (new) scrutiny of your external auditor. This may be time to lean on very experienced finance pros who understand the restatement process and whose presence could assure your auditor that it will be taken care of properly. The preparation of adjusting journal entries to fix the accounting errors in prior periods, and tracking and managing the adjustments, can be a job in itself.
5. Be Prepared for External Auditor Scrutiny Throughout the Process
During the entire time, your external auditors will be playing a big role in this process—they will be reviewing the error, coming up with their own root cause analysis, and re-looking at all the risk areas to ensure there are no additional errors lurking. To be responsive to their queries, it’s a good idea to appoint someone to facilitate dealing with the external audit team. You’ll be expected to turn around information as quickly as possible. Remember your auditors are under pressure too—they may be perceived to have missed the error as well.
6. Review Internal Controls
With any restatement, there is a presumption of a material weakness in one or more controls. You’ll need to review your internal controls and determine which controls were not properly designed or not properly executed, and how you are remediating that deficiency. This is very important to helping restore credibility with your investors so that they’ll have confidence the error won’t repeat in the future.
7. Finally, Make the Restatement
The restated interim and annual financial statements need to be drafted, with a footnote disclosure about the error correction—the nature of the error, how it occurred, how it was corrected and whether there is likely to be any future ramifications. You should also be prepared to respond to SEC comments and questions. Having someone with expertise in this area will be invaluable to your efforts.
Mistakes happen. Even after you take care to close your books accurately, record transactions in accordance with GAAP, research complex transactions and document your basis in GAAP—and even after your external auditors comb through it all and agree with your accounting—you could still find yourself facing the need for a potential restatement. Once the error is realized, it’s important to act swiftly and carefully to get the proper information out there. Finance pros who have helped companies through this same process can help you focus on all the steps in this list. They know exactly what’s needed to remediate an error, fix the previously issued financial statements and help you put processes in place to prevent history from repeating itself.
8 Lessons Learned from the 2019 Sarbanes-Oxley Season to Apply This Year
Now that the dust is settling on the 2019 financial reporting cycle, it is a great time to evaluate what went well and what you would change going forward in your Sarbanes-Oxley program. We surveyed our consultants and found a few hot spots that some companies may have overlooked in the past but shouldn’t in 2020.
1. Companies treating Sarbanes-Oxley as a risk management process tend to be more efficient.
It’s time for a robust risk assessment. Many companies are still—even after almost 20 years, treating SOX as a compliance activity when it should be considered a risk management activity. Yes, SOX is a law and must be complied with—that is a fact. But it’s also true that companies that undertake a thorough risk assessment early in the year are more likely to identify changes needed to their SOX program and anticipate areas where their external auditor may expand their focus. This provides time to consider options and implement changes that efficiently address the risk. Additionally, ongoing conversations with the external audit team will provide input as to the effectiveness of financial statement risk mitigation and can yield significant efficiencies in the audit.
2. The rigor of control documentation and testing should emphasize high-risk controls and reveal efficiencies in designing, operating and testing lower-risk controls.
With risk as the focus, doing the right thing becomes clearer: Higher risk areas such as transactions that require significant estimation should be considered for contemporaneous documentation regarding review of inputs, assumptions and conclusions. Validation of reports supporting significant journal entries should include how management reviewed the completeness and accuracy of the underlying data. This includes reports discussed further in the next point below.
At the end of the day, higher risk should result in more work, and lower risk results in less work. Some companies are getting surprised with control deficiencies or worse because they are not addressing the nuances of higher risk areas.
3. Third-party reports should not be taken at their face value.
Errors in reports, spreadsheets and information your company receives from other entities can negatively impact your financials if left unchecked. These information sources are known as “information produced by the entity” or IPE and represent a common problem area for most companies subject to SOX. To address this issue, it is best to capture report or query parameters, develop check totals and other integrity checks, and understand how the information provider checks report completeness and accuracy. All of this will help you ensure that significant errors are not unknowingly included in your financials.
Keep in mind that reports produced by service providers and business partners create the same risk and should be managed in a similar fashion. Use of such reports is an area where external auditors increased their focus in 2019, and we expect this focus to intensify in 2020.
4. Abbreviated documentation of management review controls is no longer sufficient.
A management review control is a specific type of control that, as one would expect, describes how management reviews a particular area. Commonly referred to as an MRC, these controls vary in complexity and the underlying risk of the area being reviewed. While a sign-off and date may address the risks of a bank reconciliation review, it is no longer sufficient in more complex areas such as, but not limited to, the review of reserves, accruals and intangibles. So, contemporaneously capturing the details of what the review entailed can be very helpful to substantiate the adequacy of the review. We expect audit attention to continue increasing in this area.
5. Increased use of service providers is complicating control risk management.
With the popularity of SaaS offerings and companies seeking repetitive process automation or RPA, companies can solve one problem and create another by expanding their control risk to include their service providers’ control risk.
For seasoned public companies, management is accustomed to obtaining SOC 1 reports, reviewing them and concluding on reliance. Even with this mature process, there are a few things to keep in mind. Many of the larger service providers are splitting their reports between business processes and IT. Some service providers rely on subservice providers for significant parts of their process. Auditors of the service providers are increasingly finding deficiencies and even qualifying their reports. SOC 1 report reviews need to take each of these nuances into account and determine if anything mentioned impairs the company’s ability to rely on service provider controls. All of these realities need to be addressed in the report review and considered in the reliance conclusion.
Lastly, new service providers may not have mature controls or may not offer SOC 1 reports. In any of these situations, companies should clearly know what controls they rely upon and have a fallback plan if reliance cannot be achieved.
6. Scams, especially email scams, are on the rise.
As discussed in our February blog post on Sarbanes-Oxley compliance, the frequency and severity of cybersecurity scams, including social engineering and malicious sites, are increasing. An effective SOX risk management program has to include a thorough assessment of fraud risk and appropriate controls. These include finance and information technology controls. There are practical ways to reduce these risks, and a SOX program that addresses these risks can help.
7. Process documentation does not mean step-by-step procedures.
There are few instances when a process is so complex and high volume that detailed procedures are necessary for management to understand how the risks are being managed. More often than not, process documentation that includes (1) the details of all the main types of transaction classes and (2) the controls in place specific to those transaction classes, and addresses the related risks, fulfills the need for process documentation.
So, process documentation can be in many cases a simple extrapolation of the company’s risk and control matrix from the planning process.
8. Assessing your company’s filer and reporting status may be in order.
If your company is considered, under the SEC’s definitions, a small reporting company (SRC) or an emerging growth company (EGC), or if the stock price has recently decreased, an assessment may be on tap for the reporting year. Do this early in the year and adjust accordingly.
This directive mostly applies to smaller companies that have recently gone public, but it affects larger companies as well. For a smaller company, the effort needed for an effective SOX risk management program increases when a 404(b) trigger is met. Lead time will need to be adjusted. It is the reverse for companies that fall back into the SRC definition; they might find that their SOX efforts can be streamlined. Plan ahead for these status changes.
Of course, SOX’s compliance aspects should not be overlooked. Sarbanes-Oxley, however, is rooted in risk management. Taking a risk management approach to SOX will not only help solve how to comply with SOX requirements but will also result in better risk management overall. Taking a risk-based approach can also save costs by streamlining efforts and avoiding losses due to theft and fraud.
Ken Roberts is a RoseRyan consultant who works with companies of all types in our Corporate Governance area. He’s an expert in SOX and internal control testing, and he’s held CFO, controller and internal audit roles. He also has experience with M&A integration work and operational accounting. Ken previously worked at Ernst & Young.
Coronavirus and Office Shutdowns: How to Cope With Suddenly Becoming a Remote Worker
We find ourselves in unprecedented times, with a quickly spreading virus causing drastic changes in our routine lives—from empty toilet paper shelves at the grocery store to entire workforces being asked to work from home. Working away from the office takes some getting used to if it’s new to you, and for managers, leading an entire workforce that’s becoming remote all at once will have unique challenges.
We aren’t health care experts, but as finance and accounting consultants who spend the majority of our time outside of the RoseRyan office, we are experts at remote work, and we are here to share some tips and insights, for both employees and those who will be managing them from afar.
Tips for Remote Employees
Be mindful of confidentiality—by not being in the office, you open up the risk for sensitive data being seen or heard by others. Take steps to avoid that.
Tips for Remote Managers
If you’re the one suddenly responsible for managing a remote team, we have some additional tips for you:
Schedule time for regular 1:1s and include non-work related conversation during these virtual meetups—be sure to stay connected to your team. You’ve built rapport together, and it’s important to maintain it.
RoseRyan’s dynamic team of finance and accounting aces have powered companies through a variety of obstacles and growth opportunities since 1993. To fill a gap in your finance team or take on a special project, find out what our team can do for you.