Many businesses were shut down by COVID-19, at least temporarily. As businesses reopen, a new round of challenges emerges for accountants. This blog post explores trends as businesses reopen and the related accounting effects of COVID-19.
Businesses are embracing change.
Have you noticed that the world today looks very different than just months ago?
As businesses reopen, a transformation is underway in how businesses operate. You’ve likely seen significant changes in how you work, dine, buy goods, access services, and travel. Some industries are reinventing themselves to survive. Consider restaurants, retailers, hair salons, and airlines, to name a few. Other businesses are using the pandemic as an opportunity to reimagine the workplace of the future. As businesses transform, they are incurring substantial costs to ensure customer and employee safety, allow remote work and collaboration, and adopt digital ways of doing business (such as telehealth). For instance, companies are incurring costs to provide personal protective equipment, health screenings, and frequent deep cleanings of stores, facilities, and workspaces. These additional costs must be captured for financial reporting purposes. Most of these costs will be additional expenses, but in some cases, costs may qualify for capitalization as property, plant, and equipment. For example, businesses may be reconfiguring physical space to separate individuals. Significant renovations, such as construction projects to build enclosed offices, may qualify for capitalization. Limited enhancements (such as plexiglass barriers) would likely be expensed. Businesses also may be buying new equipment to shift their product offerings. Accountants must consider new costs incurred and determine if they must be expensed or capitalized.
As businesses find new ways to operate, they also must revisit their internal controls. Controls may need to be added or modified to support new ways of doing business. Existing controls may no longer be relevant or effective. In particular, many businesses are pivoting to allow employees to work from home more regularly, which may increase cyber security and data risk and require new or enhanced controls.
At the onset of COVID-19, many businesses amended standard policies to cope with government lockdowns. These amendments often had accounting consequences. For instance, companies that updated their refund and return policies had to consider the implications on accounting for revenue. As restrictions ease, businesses must determine if measures implemented during lockdowns were only temporary or are the new normal. Companies that revert back to old policies (or otherwise change policies going forward) must be sure to capture the accounting consequences.
Businesses are learning new information.
If you’ve found it challenging to predict what business reopenings would look like, you’re not alone. During this time of uncertainty, accountants have been doing their best to make estimates and assumptions. It has been unclear when reopenings would occur, what this would entail, how consumers would behave, and how quickly businesses may recover. Now that reopenings are happening, actual results might support estimates and assumptions or show that adjustments are necessary. For instance, you will need to look closely at the estimated future cash flows used to perform asset valuations and impairment testing. If businesses struggle despite reopening, this ultimately could affect anticipated collections on receivables, expected interest and principal payments on debt, and projected revenues used in goodwill impairment analyses, among other estimated cash flows used for financial reporting purposes.
Reopenings also may give you new information to help with inventory valuations. For example, the pandemic has made it difficult to determine the net realizable value of inventory. Net realizable value is the estimated selling price in the ordinary course of business, minus reasonably predictable costs to complete, transport, and dispose of the inventory. Goods, such as apparel, have been piling up on shelves and in warehouses. Reopenings may help finally sell stagnant goods and provide insight on the net realizable value of remaining inventory.
Generally, we are learning more about consumer sentiment and behavior every day. Despite businesses reopening, many consumers are still fearful about their health, the economy, and job security. Since the onset of the pandemic, some consumers have focused on purchasing essentials, but limited discretionary spending. Many also moved to online purchases, at least temporarily. Reopenings may shine light on how fast consumers are willing to go back to their old ways, if at all. Some habits formed during the pandemic may alter behaviors long term. Reopenings may also reveal if there is pent up demand in some markets. Reopenings could also cause in-store returns to balloon if consumers have been sitting on unwanted merchandise ordered online.
Ultimately, uncertainty remains and the landscape continues to change rapidly. As new information arises, we as accountants must be prepared to capture the accounting effects of COVID-19.
Businesses are continuing to deal with the fallout from the pandemic.
Businesses are still struggling from the first wave of COVID-19 and bracing for additional waves. Accountants must continue to evaluate if there is substantial doubt about an entity’s ability to continue as a going concern.
Volatility remains in the financial markets. This volatility may also be amplified surrounding the November elections. As such, valuations and impairment analyses remain critical yet challenging.
Companies also may continue to amend contracts with customers. Some businesses are still fielding complaints from customers unable to redeem services during shutdowns. These businesses might extend the contract period, provide refunds, or otherwise offer concessions. Other businesses may have granted special benefits to customers during the worst of the pandemic, but plan to end those benefits. For example, some telecommunications entities that provided unlimited voice or data due to COVID-19 started charging again for extra minutes and usage. Reporting entities must capture the effects of contract amendments for accounting purposes. Under Topic 606, a change to a customer contract might be considered a new contract that replaces the original agreement, a modification of the original agreement, or some combination of the two.
Companies may face lawsuits related to illness or death due to COVID-19 exposure. From an accounting perspective, it may be necessary to record a liability for a loss contingency. Legislators are also working to provide protections for businesses to prevent an onslaught of personal injury or wrongful death lawsuits due to COVID-19.
Businesses are seeking relief.
Even though businesses are reopening, they still need relief to get back on their feet. Many are seeking relief through government assistance, debt restructurings, and negotiations with their landlords.
US GAAP does not specifically address how to account for government assistance for business entities. Therefore, diversity in practice exists. The FASB issued a proposal back in 2015 intended to increase transparency around the accounting for government assistance (Proposed Accounting Standards Update No. 2015-340, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance). No final standard was issued and the project is still on the FASB’s agenda. The 2015 proposal would have required disclosures to help users understand the nature of the government assistance, the significant terms and conditions of the assistance (including commitments and contingencies), the balance sheet and income statement line items affected, the amounts recorded in the financial statements, and any assistance received but not recognized in the financial statements. Reporting entities receiving government assistance due to COVID-19 (such as through forgivable loans, loan guarantees, or grants under the CARES Act) must consider the adequacy of their disclosures. The disclosures should address the relief received, the entity’s accounting, and the effects on the financial statements. Reporting entities taking advantage of tax relief also may see implications for the accounting for income taxes in their financial statements (such as effects on deferred taxes).
Businesses are also turning to debt restructurings to reduce or postpone future interest and principal payments. Even businesses that are not in financial distress may be looking to restructure debt to take advantage of the low interest rate environment. Depending on the facts and circumstances, a debt restructuring may have to be accounted for as a troubled debt restructuring, a modification of the existing debt, or an extinguishment of the existing debt.
Businesses big and small have also requested rent relief from landlords. Most commonly, lessees are requesting to defer or reduce rent payments. The FASB has issued a Staff Q&A document, Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic, discussing the appropriate accounting for lease concessions related to COVID-19. Businesses looking to sublease unused space must also account for their subleases.
Additional considerations and resources
The pandemic remains unprecedented and requires a careful eye on the accounting effects of COVID-19. Due to the unique nature of this event, US GAAP may not address every issue reporting entities encounter. Also, each reporting entity’s experience with COVID-19 may differ. Therefore, disclosures tailored to a reporting entity’s particular facts and circumstances remain paramount to help users of financial statements understand the impact of COVID-19 on an entity’s business.
The FASB’s website discusses its response to COVID-19, including summaries of actions taken by the FASB and links to submit technical inquiries. In part, the FASB has issued Staff Q&A documents addressing lease concessions, hedge accounting, and applying the taxonomy to disclosures in light of COVID-19. To ease the overall burden during the pandemic, the FASB has also delayed the effective dates of Topic 606 and Topic 842 (see ASU No. 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities) and proposed an additional one-year deferral of ASU No. 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, for all insurance entities (see Proposed ASU No. 2020-400, Financial Services—Insurance (Topic 944): Effective Date and Early Application).
In addition, the AICPA has released technical questions and answers related to COVID-19. These cover a broad range of subjects, such as accounting for restructured loans, relief under the CARES Act (including provisions involving the Small Business Administration, Paycheck Protection Program, and Provider Relief Fund), implementation costs for electronic health record (EHR) systems, and FEMA public assistance payments.
These resources are critical as we digest the current environment and determine the accounting effects of COVID-19.