The full magnitude of disruption from the pandemic is yet to be seen, and contractors will feel the impact for years to come. While the COVID-19 situation remains fluid, contractors need to be aware of how it could impact their accounting methods and financial statements.
Contractors should use their best judgment on accurately reporting information and taking advantage of deadline extensions. Consider the following Generally Accepted Accounting Principles (GAAP) requirements and disclosures.
Asset Impairments
Intangibles–Goodwill and Other (ASC Topic 350) requires businesses to perform an impairment test of goodwill and indefinite-lived intangibles at least once per year or when an event occurs. Contractors should evaluate whether COVID-19 triggers the need for an interim impairment test.
Contract Modifications
Changes in economic activity caused by the pandemic may require contractors to renegotiate the terms of existing contracts and arrangements. Examples include contracts with customers, compensation arrangements with employees, subcontractors, leases, as well as the terms of financial assets and liabilities.
Debt Modifications and Loan Covenants
Under Debt (ASC Topic 470), contractors may need to amend the terms of existing debt agreements to gain access to additional liquidity. It should be determined whether the amendments represent a debt modification, debt extinguishment or a troubled debt restructuring.
Going Concerns
Presentation of Financial Statements–Going Concern (ASC Subtopic 205-40) requires management to determine if a contractor can continue as a going concern within one year after the date the financial statements are issued. This evaluation is based on events that are known at the time the financial statements are issued. Contractors must disclose the effects of COVID-19, including financial projections, their ability to meet debt covenants, the impact of key financial ratios and other relevant information on their going concern evaluations prior to issuance.
Contractors may need to reassess financial projections and other relevant information used in their going concern evaluation for the effects of the pandemic. Adverse factors such as reduced product demand, closures and the ability to meet key performance indicators should be considered.
Hedge Accounting
Derivatives and Hedging (Under ASC Topic 815) requires that contractors asses the probability of hedge accounting and a hedged forecasted transaction occurring due to COVID-19. If a hedged forecasted transaction will not happen, hedge accounting may not be applied, and future changes in the fair value of the derivative should be recognized in earnings.
Inventory
Inventory (ASC Topic 330) requires a portion of fixed overhead to be expensed, rather than capitalized into inventory, when production levels are below normal. Fixed overhead costs are typically capitalized into the cost of inventory on a per-unit basis, based on normal capacity and production levels.
Changes to supply chains, workforce availability and consumer demand may result in decreases to the net realizable value of inventories. Contractors should assess whether the carrying value of their inventory needs to be adjusted and disclosed.
Property, Plant and Equipment
Property, Plant and Equipment (ASC Topic 360) requires that older assets be tested for recoverability whenever events or changes in circumstances indicate the carrying amount may not be recoverable. COVID-19 may change the planned use of an asset that must be disclosed.
Revenue Recognition
COVID-19 will impact current and future contracts. Revenue From Contracts With Customers (ASC Topic 606) requires that revenue is recognized when it is likely that the contractor will be paid. Contractors will need to assess whether the customer is able to pay or if write-offs are necessary. The effective date of this ASU has been pushed back to annual reporting periods beginning after Dec. 15, 2019, and interim reporting periods within annual reporting periods beginning after Dec. 15, 2020.
Variable considerations should be evaluated and disclosed on volume discounts, returns, rebates and refunds. Variable considerations are required to be estimated at contract inception and reassessed at each reporting date. They can be included in the transaction price if a significant revenue reversal will not occur.
Risks and Uncertainties
Risks and Uncertainties (ASC Topic 275) requires entities to disclose information about risks and uncertainties that could significantly change the amounts reported in the financial statements.
COVID-19 may impact a variety of significant accounting estimates related to volume discounts, variable considerations or rebates in revenue contracts; financial projections for asset impairment evaluations; or market data and other inputs used to value investments.
Contractors are required to disclose risks that exist at the date of the financial statements, as well as if the entity will become vulnerable in the near-term as a result. Disclose what happened and how COVID-19 has impacted current and future operations.
Securities
Investments–Debt and Equity Securities (ASC Topic 320), Investments–Equity Securities (ASC Topic 321) and Investments–Equity Method and Joint Ventures (ASC Topic 323) mandate that significant investments in equity securities, debt securities and equity method investments, should each be disclosed because of declines in the capital markets as a result of COVID-19.
Stock Compensation
Compensation–Stock Compensation (ASC Topic 718) requires that stock compensation arrangements with performance conditions based on the achievement of future metrics may no longer be assessed as being probable due COVID-19. Contractors may need to consider modifying award targets.
Subsequent Events
Subsequent Events (ASC Topic 855) provides guidance on the principles and requirements for subsequent events. Contractors should consider the nature of the events that occurred related to COVID-19 before the issuance of the financial statements.
Subsequent events should be recognized on the financial statements. Additional information should be disclosed relating to what happened as of the balance sheet date. Events that did not exist at the balance sheet date should not be recognized. Contractors should disclose the nature of a non-recognized subsequent event and estimate its financial impact. A statement that an estimate cannot be made may be included if the absence of a disclosure would result in misleading financial statements.
The impact of COVID-19 on the business should be considered a non-recognized subsequent event in the calendar year-end 2019 financial statements. Disclose information on the impact of government-mandated restrictions, staff reductions, investment losses and other situations.
Tax Accounting Method Changes
As contractors evaluate their capital needs, they may also consider changing to a more advantageous method of accounting and reporting for income tax purposes. For example, an entity may change its method of capitalizing costs to inventory (IRC Section 263A) or the timing of certain deductions to a more favorable method. Changes from one tax method of accounting to another may be either automatic or non-automatic under tax authority regulations.
Tax on Foreign Earnings
Taxes (ASC Topic 740) requires contractors with operations in affected areas to reevaluate their assertion of their intent and ability to indefinitely reinvest foreign earnings.
The impact of COVID-19 on financial reporting will vary based on the risks that are taken and the circumstances. Balancing the timing of reporting against the reliability and integrity of already reported information is important. Providing a fair view and presentation of the performance and position of the company will require the comprehensive disclosure of forward-looking information and cash flow impacts. Contractors must maintain an environment of integrity and transparency based on ethical decision-making.
