Further guidance on COVID-19 disclosure considerations has been issued by the Division of Corporation Finance (Division) of the U.S. Securities and Exchange Commission (SEC). The new guidance highlights the SEC’s focus on disclosure issues related to the impact of COVID-19 on companies’ operational changes and liquidity and capital resources. The guidance, Coronavirus (COVID-19) — Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (CF Disclosure Guidance: Topic No. 9A), supplements the Division’s earlier guidance, Coronavirus (COVID-19) (CF Disclosure Guidance: Topic No. 9), published on March 25, 2020, which we summarized in a recent Goodwin alert. At the same time, the staff of the SEC Office of the Chief Accountant (OCA) released a statement highlighting the importance of a number of financial reporting issues in light of COVID-19 impacts.
CF DISCLOSURE GUIDANCE TOPIC NO. 9A
The Division is continuing to monitor how companies disclose the effects and risks of COVID-19. The new guidance supplements the earlier guidance in CF Disclosure Guidance Topic 9 with additional disclosure topics for companies to consider and reflects the Division’s particular interest in disclosure about:
- Operational changes resulting from COVID-19, including supply chain and distribution adjustments that affect the company and the suspension or modification of company operations to comply with health and safety guidelines for customers, suppliers, and employees (including transitions to telework and return to workplace issues);
- Liquidity and capital resources impacts, including changes in access and use of credit facilities and public and private securities markets, changes in supplier finance programs and customer payment terms, and the impact of the financial assistance provided by the CARES Act; and
- Uncertainties about the company’s ability to continue as a going concern.
The Division emphasizes its view that robust and transparent disclosures about how companies are dealing with short- and long-term liquidity and funding risks in the current economic environment are important, particularly to the extent that companies encounter new risks or uncertainties.
The guidance states that companies should consider the following questions concerning operational considerations and the company’s liquidity position and capital resources:
- What are the material operational challenges that management and the 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?
Liquidity and Capital Resources Considerations
- How is the company’s overall liquidity position and outlook evolving? To the extent COVID-19 is adversely impacting the company’s revenues, consider whether such impacts are material to its sources and uses of funds, as well as the materiality of any assumptions the company makes about the magnitude and duration of COVID-19’s impact on its 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 its liquidity needs? Are the company’s disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of its financial condition and liquidity?
- Have COVID-19 related impacts affected the company’s ability to access its traditional funding sources on the same or reasonably similar terms as were available to the company 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 its liquidity decreasing in a way that would result in the company being unable to maintain current operations?
Covenant Defaults; Debt Service
- Is the company at material risk of not meeting covenants in its credit and other agreements?
- Is the company able to timely service its 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? Does the company foresee any liquidity challenges once those accommodations end?
Financial Metrics Disclosure
- If the company include metrics, such as cash burn rate or daily cash use, in its disclosures, is it 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 about which the disclosure is necessary for the metric not to be misleading?
Capital Expenditures; Share Repurchase Plans/Dividends; Disposition of Assets; Termination/Disposition of Business Operations or Lines
- Has the company reduced its 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 its human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long does the company expect to maintain them? What factors will the company consider 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?
Changes in Terms with Customers, Tenants, or Borrowers
- Has the company altered terms with its customers, such as extended payment terms or refund periods, and if so, how have those actions materially affected its 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 its financial condition, liquidity, and capital resources?
Supply Chain or Vendor Financing
- 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 its 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?
Events Occurring After End of Reporting Period but Before Issuance of Financial Statements
- Has the company assessed the impact 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?
CARES Act and Government Assistance
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. These considerations also apply to foreign private issuers that receive assistance from their home country. The guidance states 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 the company 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 its cost of capital? Does the company reasonably expect restrictions, such as maintaining certain employment levels, to have a material impact on its 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 its 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 Uncertainties
If COVID-19 impacts have given rise to substantial doubts about a company’s ability to continue as a going concern, or if management plans have alleviated the substantial doubts about going concern qualifications, management should provide the appropriate respective disclosures in the financial statement and consider the following questions when preparing 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?
OCA STATEMENT ON THE CONTINUED IMPORTANCE OF HIGH-QUALITY FINANCIAL REPORTING FOR INVESTORS IN LIGHT OF COVID-19
The OCA statement highlights the OCA’s engagement with public companies, auditors, audit committees, other regulators and standard setters, investors, and others to promote “high-quality financial reporting.” The OCA statement expands and supplements an earlier statement released on April 3, 2020. The sections of the OCA statement of principal interest to companies include discussion and reminders about a number of financial reporting issues and the role of audit committees.
OCA Engagement and Work Related to High-Quality Financial Reporting
Significant Estimates and Judgments
- 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.
Disclosure Controls and Procedures and Internal Control over Financial Reporting
- Some companies have modified their disclosure controls and procedures and internal control over financial reporting (ICFR) to reflect COVID-19 impacts. The OCA statement reminds companies that if any change materially affects, or is reasonably likely to materially affect, a company’s ICFR, the company must disclose the change in its Form 10-Q report (or Form 10-K report, in the case of the fourth quarter) for the fiscal quarter in which the change occurred. Foreign private issuers are subject to a similar requirement for their annual reports.
Going Concern Reminders
- Management should consider whether relevant 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 company’s quarterly or annual financial statements. If there are substantial doubts, management should consider whether or not its plays may alleviate these doubts, and include additional required disclosure. Generally accepted accounting practices (GAAP) in the U.S. require these disclosures in the notes to the financial statements, and SEC rules may require additional disclosure in SEC filings.
- The OCA statement also reminds auditors that although the 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, if the auditor becomes aware of such conditions or events in the course of performing review procedures, the auditor should inquire with management and consider whether the relevant disclosures comply with GAAP.
Consultation with OCA on Complex or Emerging Issues in Financial Reporting
- During the first quarter of 2020, the OCA consulted with issuers and auditors concerning complex financial reporting issues. These issues included the financial reporting ramifications of the CARES Act, debt modifications, hedging, consolidation, business combinations, lease concessions, revenue recognition, and income taxes. The OCA statement reminds companies and auditors that the OCA remains available for consultation about the application of GAAP and International Financial Reporting Standards to complex, unique, and novel issues. The OCA statement also highlights the importance of auditor independence, which is the shared responsibility of the company’s audit committee, management, and auditor.
OCA Engagement with and the Vital Role of Audit Committees
The OCA statement emphasizes the key role of the audit committee in the financial reporting system through oversight of companies’ financial reporting, including ICFR and the external, independent audit process. The OCA will continue to be proactive in engaging with audit committee members in a two-way dialogue to understand current market developments as well as to solicit their perspectives on improving the oversight of financial reporting.