The COVID-19 pandemic has rapidly impacted companies in unprecedented ways and given rise to extraordinary economic and commercial uncertainty. Given this environment, and the likelihood that such uncertainty will remain for the foreseeable future, companies need to be proactive in assessing risks to their businesses and changes to their financial reporting and internal control environments. More than ever, companies will need to have robust controls and procedures in place to enable them to disclose material information related to COVID-19 in a timely manner - a consideration that has been reinforced by the Securities and Exchange Commission.
Two negative financial reporting trends have already become more prevalent as a result of the fallout from COVID-19: asset impairments and adverse conditions. These, in particular, are giving rise to substantial doubt about companies’ ability to continue as a going concern.
Issuers are required to (i) assess the impairment of nonfinancial assets at the end of each reporting period, and (ii) perform an impairment test when potential impairment triggers are identified. The negative economic impact of the COVID-19 pandemic undoubtedly provides a basis for impairment testing for long-lived assets, including goodwill, intangible assets, inventory, and property, plant and equipment for companies across a broad range of industries. While the economic downturn has impacted businesses of all kinds, some particularly hard hit sectors - including airlines, casinos & gaming, hospitality, and oil and gas drilling - have seen industry leaders report impairment losses in their most recent quarterly filings. Our expectation is that this trend will continue and could affect a greater array of industries going forward.
Well ahead of their quarterly financial reporting close, companies should be carefully considering potential asset impairment triggers. Impairment testing will likely require significant lead time and the expertise of an outside valuation expert, so timely identification of triggering events and circumstances will prove vital. Some examples of impairment triggers include significant actual or forecasted:
- Declines in revenue as a result of voluntary or mandated temporary facility closures, or loss of a major customer or segment
- Supply chain disruption
- Limitations on access to capital
- Increases in raw material, labor or other costs
- Continued deterioration of general economic conditions
- Decline in the market value of the issuer’s stock
When impairment triggers are identified and impairment testing is underway, companies subject to economic turbulence will face challenges in developing forecasted cash flows. To the extent that companies have uncertainty in the models used in their valuation calculations, they should disclose any assumptions and the potential impact of related variabilities.
Impairments are likely to become increasingly common as the pandemic continues. Companies should therefore recognize likely charges to the extent appropriate.
It is often said that cash is king, and that is more true in today’s environment than at any other time in recent history. Companies should ensure that they are properly managing their cash flow, which may be significantly reduced now and through the near-term. Reduced cash flow may generate doubt concerning an entity’s ability to continue as a going concern over the next 12 months, at least. Recent issuer filings show an uptick in the number of companies reporting substantial uncertainty to this effect. It is imperative that companies be timely in identifying the issues that could give rise to uncertainty, and devise a strategy to mitigate adverse conditions as much as possible.
Management’s going concern assessment studies conditions that are known and reasonably knowable at the issuance date. The extent to which companies will be required to consider such substantial doubt is heavily dependent on the individual facts and circumstances of the entity. Namely, the degree to which they are reliant on:
- External debt or equity financing sources,
- Concentrated groups of suppliers or customers, or
- Other dynamics that could leave them susceptible to insufficient liquidity in the short-term.
If you need help assessing your company’s exposure to negative reporting trends, contact a Friedman advisor today.