As the COVID-19 pandemic and the measures taken to prevent the spread of the disease continue to affect public companies, the staff of the Office of Chief Accountant and the Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC) have provided further guidance for companies to consider when preparing upcoming disclosures. These statements emphasize the importance of high-quality financial reporting and a focus on meaningful disclosure about operations, liquidity, and capital resources during the COVID-19 pandemic.

Statement of the SEC’s Chief Accountant

On June 23, 2020, Sagar Teotia, Chief Accountant of the SEC, issued a statement noting that, during the course of the COVID-19 pandemic, “the financial reporting system has continued to serve its critical function of providing much-needed information to investors and our capital markets.”[1] In the statement, the Chief Accountant highlights recent engagement with stakeholders in the financial reporting system, as well as significant accounting, auditing, and financial reporting issues addressed by the SEC’s Office of Chief Accountant (OCA).

OCA Engagement with Companies and Auditors

Referencing recent statements made by SEC Chairman Jay Clayton, the Chief Accountant notes that “investors, and our public capital markets more generally, have a thirst for clear, high-quality, timely information regarding the financial and operating status of companies, as well as their future prospects.”

Significant Estimates and Judgments

Recognizing that companies must make significant judgments and estimates to address a variety of accounting and financial reporting matters, the Chief Accountant notes that OCA has “consistently not objected to well-reasoned judgments that entities have made, and we will continue to apply this perspective.” The Chief Accountant notes that companies should ensure that significant judgments and estimates “are disclosed in a manner that is understandable and useful to investors, and that the resulting financial reporting reflects and is consistent with the company’s specific facts and circumstances.”

Controls

The Chief Accountant notes that OCA continues to emphasize the importance of “robust internal accounting controls to high-quality, reliable financial reporting,” which include disclosure controls and procedures and internal control over financial reporting. The Chief Accountant notes that OCA understands that preparers have adapted, or are in the process of adapting, their financial reporting processes as they respond to the current environment. The Chief Accountant indicates that these changes could include considerations as to “how controls operate or can be tested and if there is any change in the risk of the control operating effectively in a telework environment.” The Chief Accountant notes that changes to a company’s business, as well as additional uncertainties, may result in additional risks of material misstatement to the financial statements, therefore new or enhanced controls may need to be implemented in order to mitigate such risks. OCA reminds preparers that if any change materially affects, or is reasonably likely to materially affect, a company’s internal control over financial reporting, such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred (or fiscal year in the case of a foreign private issuer).

“Going Concern” Considerations

The Chief Accountant notes that U.S. GAAP presumes that a reporting entity has the ability to continue as a going concern. OCA reminds companies that in each reporting period, including interim periods, “management should consider whether relevant conditions and events, taken as a whole, raise substantial doubt about the entity’s ability to meet its obligations as they become due within one year after the issuance of the financial statements.” In those situations where substantial doubt about a company’s ability to continue as a going concern exists, “management should consider whether its plans alleviate such substantial doubt, and make appropriate disclosures to inform investors.” The Chief Accountant notes that “such disclosures should include information about the principal conditions giving rise to the substantial doubt, management’s evaluation of the significance of those conditions relative to the entity’s ability to meet its obligations, and management’s plans that alleviated substantial doubt.” If, after considering management’s plans, substantial doubt about a company’s ability to continue as a going concern is not alleviated, additional disclosure is required pursuant to GAAP. OCA notes that GAAP requires such disclosure in the notes of the financial statements, which may be in addition to other disclosure required in SEC filings.

The Chief Accountant also indicates that auditors have responsibility to evaluate a company’s ability to continue as a going concern, “based on their knowledge of relevant conditions that exist at or occurred prior to the date of the auditor’s report.” While acknowledging that a review of interim financial information “is not designed to identify conditions or events that indicate substantial doubt about an entity’s ability to continue as a going concern,” the Chief Accountant notes that an auditor “may become aware of such conditions or events in the course of performing review procedures.” The Chief Accountant reminds auditors that, in these situations, the auditor should discuss the matter with management and consider the adequacy of the disclosure in light of the GAAP requirements. OCA reminds auditors that, after performing such procedures, “to the extent the auditor determines the relevant disclosure is inadequate such that it represents a departure from GAAP, the auditor should extend the procedures, evaluate the results and communicate as appropriate with the issuer and its audit committee.”

Complex Financial Reporting Issues

Based on OCA’s consultation process and outreach with public companies, auditors, and others, the Chief Accountant believes that complex financial reporting issues that arose at the onset of the pandemic were addressed effectively and in a timely manner. The Chief Accountant provides a reminder that OCA has processes in place to provide staff views on the application of U.S. GAAP and International Financial Reporting Standards (IFRS) to complex, unique, or novel issues. The Chief Accountant reports that issues addressed by OCA over the first quarter reporting cycle included the financial reporting ramifications of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), debt modifications, hedging, consolidation, business combinations, lease concessions, revenue recognition and income taxes. As companies and auditors enter the second quarter reporting cycle, OCA expects to continue to address financial reporting issues as they arise, and the Chief Accountant encourages engagement with OCA on questions arising from COVID-19 or other emerging issues, as well as auditor independence issues.

OCA Engagement with the FASB and the PCAOB

The Chief Accountant notes that OCA continues to be actively engaged with standard setters, other regulators, and related groups in the U.S. and internationally. The Chief Accountant reports that OCA has been in constructive dialogue with the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB) “regarding their respective efforts to address emerging issues and promote high-quality financial reporting.”

FASB

OCA commends the FASB for “its focus on monitoring the financial reporting landscape to identify emerging issues due to the impact of COVID-19, including being open and responsive to feedback from investors and other stakeholders regarding issues that affect the FASB’s standard-setting agenda.” OCA is working closely with the FASB on issues related to the impact of COVID-19, providing feedback on standard-setting projects, observing FASB meetings, and sharing recent experiences on a wide range of other topics. OCA has also been working with the Board of Trustees of the Financial Accounting Foundation (FAF) in support of its responsibility for the oversight, administration, and finances of the FASB, and has supported the leadership transition of the FASB.

PCAOB

The Chief Accountant notes that the PCAOB “continues to focus on its mission to oversee the audits of public companies and SEC-registered brokers and dealers in order to protect investors and further the public interest in the preparation of informative, accurate and independent audit reports.” The Chief Accountant notes that the PCAOB swiftly transitioned to remote operations and has demonstrated flexibility during the COVID-19 pandemic, granting a 45-day relief period from inspections to afford registered firms the time, resources, and flexibility to work through their own significant matters. The Chief Accountant also notes that the PCAOB published information with important reminders for auditors engaged in audits nearing completion.

OCA Engagement with International Standard Setters and Other Regulators

The Chief Accountant notes that “international accounting and audit-related standards are therefore also of paramount importance to the strength of the financial reporting system, global capital markets and investor protection,” therefore OCA actively engages with international standard setters and regulators.

International Accounting Standards

OCA actively participates in the development of high-quality IFRS standards and their application, working within the International Organization of Securities Commissions’ (“IOSCO”) Committee 1 on Issuer Accounting, Audit, and Disclosure to develop comment letters in response to IASB proposals, and participates in multilateral discussions with the IASB. OCA also engages in a direct dialog with the IASB and its staff on topics of mutual interest, such as application of the IFRS leasing standard to rent concessions made as a consequence of COVID-19. Through the SEC’s participation in the IFRS Foundation Monitoring Board, OCA monitors the governance of the IFRS Foundation and the IASB.

International Audit Standards

The Chief Accountant notes that international audit-related standard setting is facilitated by the International Federation of Accountants, with oversight provided by the Public Interest Oversight Board. The SEC participates in the development and implementation of reforms to the international audit-related standard-setting system through its involvement in the Monitoring Group.

IOSCO

The Chief Accountant notes that the SEC has been working with securities regulators around the world in response to the effects of COVID-19 through the work on IOSCO’s Committee 1 and has otherwise been actively engaged with other regulators. IOSCO issued a statement on May 29, 2020 emphasizing “the importance of complying with accounting and auditing standards as well as providing investors with complete, transparent and entity-specific disclosures that enable investors to better understand the risks that public companies are facing in the current environment of heightened uncertainty.”

Role of Audit Committees

The Chief Accountant reiterates that audit committees play a key role in the financial reporting system through their oversight of financial reporting, including internal control over financial reporting and the external, independent audit process. The Chief Accountant notes that, “[i]n these times of rapid change and increased uncertainty, the need for the oversight role that audit committees play is as critical as ever.” The Chief Accountant expresses the view that “the most effective audit committees are engaged, executing their responsibilities with diligence, and this engagement significantly enhances the financial reporting output.” Further, it is noted that OCA’s “ongoing two-way dialogue with audit committee members and related organizations is a crucial component of our efforts to promote high-quality financial reporting.”

CF Disclosure Guidance: Topic No. 9A, Coronavirus (COVID-19) – Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources

On June 23, 2020, the staff of the Division of Corporation Finance published CF Disclosure Guidance: Topic No. 9A (the “Disclosure Guidance”), which addresses operations, liquidity, and capital resources disclosures companies should consider with respect to business and market disruptions related to COVID-19.[2]

Background

On March 25, 2020, the SEC’s Division of Corporation Finance published CF Disclosure Guidance: Topic No. 9 – Coronavirus (COVID-19), in which the staff provided its views regarding the disclosure obligations that public companies should consider in light of the circumstances presented by the COVID-19 pandemic.[3] The Disclosure Guidance notes that the Division continues to monitor how companies are disclosing the effects and risks of COVID-19 on their businesses, financial condition, and results of operations, and is supplementing CF Disclosure Guidance Topic No. 9 with guidance regarding additional disclosure considerations. The Staff continues to encourage companies “to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change.” That staff notes that “[t]hese disclosures should enable an investor to understand how management and the Board of Directors are analyzing the current and expected impact of COVID-19 on the company’s operations and financial condition, including liquidity and capital resources.”

Operations, Liquidity, and Capital Resources

The staff notes in the Disclosure Guidance that companies have undertaken, and are generally in the process of making, a diverse range of operational adjustments in response to the effects of COVID-19. Among the adjustments that the Staff notes are a transition to telework; supply chain and distribution adjustments; and suspending or modifying certain operations to comply with health and safety guidelines to protect employees, contractors, and customers, including in connection with a transition back to the workplace. The Staff notes that these types of adjustments “may have an effect on a company that would be material to an investment or voting decision, and affected companies should carefully consider their obligations to disclose this information to investors.”

The staff also notes that companies “are undertaking a diverse and sometimes complex range of financing activities in response to the effects of COVID-19 on their businesses and markets,” which include obtaining and utilizing credit facilities, accessing public and private markets, implementing supplier finance programs, and negotiating new or modified customer payment terms. The staff notes that these funding sources may include novel terms and structures. The staff indicates that “[i]t is important that companies provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties to their businesses. While we have observed companies making some of these disclosures in their earnings releases, we encourage companies to evaluate whether any of the information, in light of its potential materiality, should also be included in MD&A.”

The staff encourages companies to consider a number of questions as they analyze their specific facts and circumstances and consider their disclosure obligations, including:

• What are the material operational challenges that management and the company’s board of directors are monitoring and evaluating? How and to what extent has the company altered its operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace? How are the changes impacting or reasonably likely to impact the company’s financial condition and short- and long-term liquidity?
• How is the company’s overall liquidity position and outlook evolving? If COVID-19 is adversely impacting a company’s revenues, the staff indicates that the company should consider whether such impacts are material to the company’s sources and uses of funds, as well as the materiality of any assumptions made about the magnitude and duration of COVID-19’s impact on your revenues. Are any decreases in cash flow from operations having a material impact on the company’s liquidity position and outlook?
• Has the company accessed revolving lines of credit or raised capital in the public or private markets to address liquidity needs? Are the company’s disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of your financial condition and liquidity?
• Have COVID-19-related impacts affected the company’s ability to access traditional funding sources on the same or reasonably similar terms as were available in recent periods? Has the company provided additional collateral, guarantees, or equity to obtain funding? Have there been material changes in the company’s cost of capital? How has a change, or a potential change, to the company’s credit rating impacted its ability to access funding? Do the company’s financing arrangements contain terms that limit its ability to obtain additional funding? If so, is the uncertainty of additional funding reasonably likely to result in a decline in the company’s liquidity in a way that would result in the company not being able to maintain current operations?
• Is the company at material risk of not meeting covenants in credit and other agreements?
• If a company includes metrics, such as cash burn rate or daily cash use, in its disclosures, is the company providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity? Are there estimates or assumptions underlying such metrics, the disclosure of which is necessary for the metric not to be misleading?
• Has the company reduced capital expenditures and, if so, how? Has the company reduced or suspended share repurchase programs or dividend payments? Has the company ceased any material business operations or disposed of a material asset or line of business? Has the company materially reduced or increased human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long will they be maintained? What factors will be considered in deciding to extend or curtail these measures? What is the short- and long-term impact of these reductions on the company’s ability to generate revenues and meet existing and future financial obligations?
• Is the company able to timely service debt and other obligations? Has the company taken advantage of available payment deferrals, forbearance periods, or other concessions? What are those concessions and how long will they last? Are any liquidity challenges possible once those accommodations end?
• Has the company altered terms with customers, such as extending payment terms or refund periods, and if so, how have those actions materially affected the company’s financial condition or liquidity? Did the company provide concessions or modify terms of arrangements as a landlord or lender that will have a material impact? Has the company modified other contractual arrangements in response to COVID-19 in such a way that the revised terms may materially impact the company’s financial condition, liquidity, and capital resources?
• Is the company relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage cash flow? Have these arrangements had a material impact on the company’s balance sheet, statement of cash flows, or short- and long-term liquidity and, if so, how? What are the material terms of the arrangements? Did the company or any of its subsidiaries provide guarantees related to these programs? Does the company face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for the company?
• Has the company assessed the impact that material events that occurred after the end of the reporting period, but before the financial statements were issued, have had or are reasonably likely to have on its liquidity and capital resources and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?

The CARES Act

The Disclosure Guidance notes that the CARES Act includes financial assistance for companies in the form of loans and tax relief in the form of deferred or reduced payments and potential refunds. The staff indicates that “companies receiving federal assistance should consider the short- and long-term impact of that assistance on their financial condition, results of operations, liquidity, and capital resources, as well as the related disclosures and critical accounting estimates and assumptions.” The staff suggests that companies should consider the following questions:

• How does a loan impact the company’s financial condition, liquidity, and capital resources? What are the material terms and conditions of any assistance received, and does the company anticipate being able to comply with them? Do those terms and conditions limit the company’s ability to seek other sources of financing or affect the company’s cost of capital? Does the company reasonably expect restrictions, such as maintaining certain employment levels, to have a material impact on revenues or income from continuing operations or to cause a material change in the relationship between costs and revenues? Once any such restrictions lapse, does the company expect to change its operations in a material way?
• Is the company taking advantage of any recent tax relief, and if so, how does that relief impact short- and long-term liquidity? Does the company expect a material tax refund for prior periods?
• Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate? What accounting estimates were made, such as the probability a loan will be forgiven, and what uncertainties are involved in applying the related accounting guidance?

Going Concern Considerations

The Disclosure Guidance indicates that “[m]anagement should consider whether conditions and events, taken as a whole, raise substantial doubt about the company’s ability to meet its obligations as they become due within one year after the issuance of the financial statements. Where there is substantial doubt about a company’s ability to continue as a going concern or the substantial doubt is alleviated by management’s plans, management should provide the appropriate respective disclosures in the financial statements and consider the following questions regarding the company’s MD&A disclosure:

• Are there conditions and events that give rise to the substantial doubt about the company’s ability to continue as a going concern? For example, has the company defaulted on outstanding obligations? Has the company faced labor challenges or a work stoppage?
• What are the company’s plans to address these challenges? Has the company implemented any portion of those plans?

Conclusion

Companies that have been impacted by the COVID-19 pandemic and the associated economic circumstances should consider the recent guidance from the SEC staff when preparing financial statements and disclosures required in upcoming SEC reports. We expect that the SEC staff will continue to monitor the disclosures in SEC reports and provide additional guidance when necessary.

[1] Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19 (June 23, 2020), available at: https://www.sec.gov/news/public-statement/teotia-financial-reporting-covid-19-2020-06-23.

[2] CF Disclosure Guidance: Topic No. 9A, Coronavirus (COVID-19) — Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (June 23, 2020), available at: https://www.sec.gov/corpfin/covid-19-disclosure-considerations.

[3] See our client alert titled: Guidance for Public Companies on Signatures and Disclosure Considerations in Light of COVID-19, available at: https://www.mofo.com/resources/insights/200326-signatures-and-disclosure-considerations-in-light-of-covid-19.html.

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