Public companies are filing Form 10-Ks with 2020 results. And analysts with credit ratings agency Moody’s Investors Service said they are starting to see a range of reporting practices to highlight how the COVID-19 pandemic affected companies’ financial performance last year.
In terms of non-GAAP metrics, Moody’s said there are various presentations. Many companies are highlighting individual pandemic-related transactions rather than providing the total numerical effects. More companies are likely to realize that one-time expense is becoming a recurring expense.
Moody’s said some practices remain questionable, such as EBITDAC (Earnings Before Interest, Taxes, Depreciation, Amortization, and Coronavirus).
There has been an increase in delayed filings and going concern disclosures as companies experienced decreased revenues or disappearing revenue. Going concern is about a company’s ability to stay afloat.
“Many are also dealing with other issues such as increased bad debts, asset impairments, restructuring charges, increased payroll expenses for bonuses and severance, as well as direct pandemic expenses such as personal protective equipment and cleaning supplies,” Moody’s analysts wrote in a March 8, 2021, Sector Comment. “However, there have also been positive changes, including tax deferrals, government grants, low interest loans and cost savings from a drop in business travel. With so much disruption to results, it leaves many investors wondering whether pandemic related adjustments are worth the effort.”
The largest public companies must file with the SEC by the end of February, smaller public companies file in March, and private companies follow soon thereafter.
In terms of going concern filings, in many cases, they were directly related to the pandemic’s effect on upcoming principal payments or projected violations of financial covenants, Moody’s found.
Companies also delayed filings because they worked to resolve going concern issues before finalizing their financial statements. Company management, under the FASB’s standard, must disclose if it is “probable” that the company will not be able to pay debts as they come due during the next 12 months. Auditors must then assess whether there is “substantial doubt” about the company’s going concern. If there is, the auditor needs to report it in the auditor’s opinion.
“Typically, management’s going concern assessment does not affect compliance with credit agreements,” Moody’s said. “However, receiving a going concern opinion from the auditor’s assessment can have more significance. Most credit agreements require the delivery of year-end financial statements to be certified by independent certified public accountants without qualification or doubt regarding an entity’s ability to remain a ‘going concern.’”
Moody’s analysts wrote that the accounting standards only allow consideration of executed plans at the time going concern is assessed. Future plans, such as debt refinancing or equity raising, cannot be considered until it is complete.
The accounting standards only allow consideration of executed plans at the time of the going concern assessment. Future plans, such as debt refinancing or raising equity, cannot be considered until such action is complete.
“Therefore, companies with a credit agreement requirement to have an audit without a going concern qualification will often delay issuance of the financial statements until the issue is resolved by executing a waiver of the covenant requirement or a refinancing,” the credit analysts explained. “Investors should suspect going concern issues for companies that delay issuance of their financial statements.”
Adoption of CECL
To help soften the blow from efforts to combat COVID-19, Congress a year ago passed the Coronavirus Aid, Relief and Economic Security (CARES) Act, which included a provision allowing banks the option to delay adopting the FASB’s new Current Expected Credit Losses accounting standard (CECL). This requires banks to recognize losses early in the credit cycle. Large financial institutions that file with the SEC had 2020 adoption date. And bank regulators gave them the option to delay reporting the impact on regulatory capital.
Moody’s said banks in general chose not to delay CECL adoption. However, they did elect to defer the regulatory capital impact.
“Because each bank’s choices have an impact on provision levels, capital and risk weighted assets—major indicators of a bank’s performance—it is important for investors to understand these choices,” the research noted. “We expect each bank to provide clear disclosure regarding these government actions and the choices they made in the 2020 Form 10-K.”
In the meantime, Moody’s said there have been significant improvements in disclosures made around methodologies, quantitative metrics, and significant assumptions made when coming up with estimated losses and corresponding reserves. And analysts expected this trend to continue.
Moody’s said governments around the world assisted companies through grants, expense reimbursements, and loans with below-market interest rates. The IASB’s IFRS contains accounting rules addressing government assistance, but the FASB does not have clear guidance in U.S. GAAP. This meant that there has been diversity in practice among U.S. companies.
“To understand whether the relevant reporting reflects the analytic view or requires adjustment for one-offs, it is important to understand the government support received, the timing of receipt and the recognition. In most cases reported throughout 2020, we have found that reporting is keeping with our analytic view, such as offsetting expenses or gain recognition in non-operating income,” Moody’s said. “However, in some instances we adjust for unusual one-time gains.”