By Soyoung Ho
With Coronavirus spreading across the globe and starting to adversely impact businesses that have operations in China, U.S. SEC Chairman Jay Clayton in February 2020 issued a statement, emphasizing that publicly-listed companies need to consider providing “subsequent event” disclosures to investors.
But the SEC also said it would follow its general policy “to grant appropriate relief from filing deadlines in situations where, in light of circumstances beyond the control of the issuer, filings cannot be completed on time with appropriate review and attention.” And David Brown, a partner with Alston & Bird LLP in Washington, said he thinks the SEC is treating the Coronavirus similarly to how it has dealt with other natural disasters, whether it is a hurricane or tsunami, for example, to do two things.
“Number one, understand that public companies can go through natural disasters or other types of very disruptive large-scale events that affect more than one public company,” Brown said. “And two, to remind them to make disclosures as quickly as possible … to their investors but understand that these large-scale issues may disrupt things that are normally ordinary course like audit and other measures. So, to the extent that they [the SEC] can either be helpful or accommodating to that, I think they want to do that…noting that their core mission is to protect investors. A way to do that is through disclosure and making sure that the public companies that need to file the reports do so. If they can’t do it timely, do it as quickly as possible.”
One particular disclosure area of attention should be on the risk companies face, Brown noted.
Currently, most calendar year-end companies are starting to file their Form 10-Ks, and if companies have not already filed their annual reports, companies should look at their risk disclosures more closely.
Because the Coronavirus itself and its effect on the market remain fluid and uncertain, Brown said companies are currently doing the best they can at the time they file financial reports with the SEC.
But “I think two months from now, we will see… where it goes from the risk factor,” Brown said. “If the situation continues to either be disruptive to U.S. public companies or the financial markets otherwise, the SEC will start to expect those risk factor-type disclosures to translate in your MD&A [management’s discussion and analysis]. And as management discusses these types of trends, what kind of impact will it have on their business, why did it have this impact on your business, and you will start to see companies describe that.”
Furthermore, “if companies are not adequately either describing those risks or more importantly the impact on their business, then you will see SEC comment letters to the extent that they should describe it that way,” Brown said. The SEC staff sends out comment letters to individual companies if the staff finds insufficient disclosures.
Jack Ciesielski, an investment manager who previously wrote The Analyst’s Accounting Observer, agreed and reminded companies to really pay attention to disclosures.
“The onus to provide subsequent events information is on companies if they want to avoid lawsuits,” he said. “I think the SEC had the disclosure jawboning right, but I think it’s going to wind up being almost continuous disclosure until the time that the virus slows down.”
In the meantime, Paul Gillis, a professor of management at Peking University who writes China Accounting Blog, believes the accounting implications of Coronavirus will be significant and said accounting standard-setters may need to provide further application guidance on subsequent events.
The FASB’s Accounting Standards Codification (ASC) 855, Subsequent Events, requires companies to disclose events or transactions that occur after the balance sheet date but before financial statements are issued, and there are two types of subsequent events. One is events that provide additional evidence about conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. The other is about events that provide evidence about conditions that did not exist at the date of the balance sheet being reported on but arose after that date.
Moreover, ASC 450, Contingencies, outlines the accounting and disclosure requirements for loss and gain contingencies. The accounting standard requires companies to accrue for potential lawsuits based on the probability that a claim will be made and loss will be incurred.
Gillis wrote that many companies will have lower financial results in China, and some may not even survive because they do not have adequate resources. In his view, auditors must figure out whether negative going concern opinion—the company’s ability to stay afloat—should be issued.
“Going concern issues are typically resolved on subsidiaries of multinational companies through the issuance of a support letter from the parent company which assumes the parent has sufficient resources to survive the crisis,” he wrote.
Even when there is no going concern issue, he said the issue is whether to accrue the novel virus-related losses in 2019 or to report them in 2020. Most companies have had little business in January and February this year because of Chinese New Year holidays and because of mandatory closures related to Coronavirus.
“Should losses related to the virus be accrued as of December 31? The event that caused the loss began in 2019,” he wrote. “Secondly, each company must determine in the preparation of 2019 financial statements if any assets are impaired. Any impairment is recorded as an expense. Of particular concern will be intangible assets such as goodwill. Many Chinese companies have considerable goodwill on their balance sheet due to acquisitions. Goodwill is typically tested for impairment by looking at future cash flows from the related business. Those cash flows have been altered by the virus, and potentially significantly enough that goodwill must be impaired.”
Alston & Bird’s Brown added that there will be additional pressure not only on the companies but also on their auditors.
“If they don’t have typical access to Chinese personnel or systems or things like that because they are just not available, then the auditors will probably have to work extra hard to get comfortable that they satisfy their auditing standards where there might be some gaps in their typical procedures,” he said. “So, they might have to ramp up other procedures, and that’s what you get into the SEC being accommodating for any potential delay and making their filings. But I think the auditing firms will probably hopefully work closely with their clients to figure out a stop gap solution.”
Further, the pressures on companies based in China whose shares trade on U.S. stock markets are greater since the PCAOB has been blocked from conducting inspections of auditors there.
This article originally appeared in the March 4, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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