Financial reporting isn’t getting any easier under COVID-19
Now that U.S. companies have experienced two fiscal quarters in the midst of the novel coronavirus pandemic, quarterly reporting for Q3 doesn’t seem to be getting any simpler, according to a new report from Deloitte.
The report found that companies should still be vigilant about treating Q3 reporting the same way as Q2, despite the leeway that the Securities and Exchange Commission and the Financial Accounting Standards Board granted them at the start of the pandemic earlier this year. The third quarter, and probably the fourth as well, will still provide plenty of new challenges as long as COVID-19 is having a measurable impact on the market. While some issues such as forecasting and stakeholder communications will persist from Q1 and Q2 of this year, companies are finding that adjustments to stock compensation and modifications to contractual agreements will be needed, thanks to prolonged uncertainty and growth concerns for at least the remainder of this year, and probably next year as well.
“Companies continue to face challenges related to forecasting as a result of the ongoing uncertainties associated with the COVID-19 pandemic,” said the report. “Looking across the economic landscape, one might observe a tale of two markets: companies that are being challenged to get back to pre-outbreak operations and those that are benefiting from the outbreak.”
Deloitte pointed out that for many companies negatively affected by COVID-19, it has observed the development of forecasts that use pre-COVID-19 results as an initial target on which the companies have based their assumptions for the resumption of “normal growth.” Instead, companies should ask themselves whether achieving pre-COVID-19 results in the near term is reasonable or whether they’re facing a “new normal” given the potential continuation of the existing economic environment or a permanent shift in their business models as a result of the pandemic.
“It's becoming apparent that the situation with COVID isn't going away,” said Eric Knachel, a senior consultation partner in Deloitte’s National Office of Accounting Services, who wrote the report. “Everyone’s impacted. Individually for us, our personal lives may feel like every day has kind of blended together, almost like ‘Groundhog Day.’ From the company's perspective, if they’re able to survive, they're trying to figure out how to maximize performance during these times, and then how do they prepare to come out stronger at the end of it. It's important for companies to recognize that they can’t approach this current environment as though it's just another COVID-19 quarter. Your competitors are moving ahead and you can’t stand still. In reality you aren't really standing still; you're falling behind. They need to be proactive from a business standpoint.”
That goes for their accounting as well. Effective disclosure and communication of transactions are paramount now. “A company will have to be very transparent about any kind of unusual activity that they have,” said Knachel. “That can mean different types of transactions, whether it's combinations, restructurings, insurance recoveries, government grants, the things that are out of the ordinary. They have to talk about what is really happening and then also indicate how they're accounting for it and where it's presented in the financial statements.”
In communicating with investors and financial analysts, companies will need to highlight their liquidity and cash flow. “There's a focus on where the company is from a liquidity standpoint, and what they are projecting in terms of cash needs and cash flows,” said Knachel. “There's a bit more focus on when you actually will be collecting this cash and when you have to pay down this debt. Investors want to understand because liquidity and cash can be a very significant issue.”
Non-GAAP metrics will also be an important focus. “In the first quarter, we didn't see a lot of non-GAAP metrics because the impact of COVID-19 was only for a couple of weeks,” said Knachel. “Q2 ended June 30 and you had a full period of it, so we did see a lot more, and we're expecting to see the same in the quarter ending Sept. 30. However, while we have seen more in the way of non-GAAP, we haven't seen as much as we would have thought.”
Companies also have to deal with all the changing accounting standards in areas such as leases, credit losses, hedging and other areas, even though FASB gave them some extra time by deferring the effective dates in the wake of the pandemic.
“Most companies are not necessarily looking to take advantage of extensions, so it's not so much that they feel overwhelmed and don't know what to do,” said Knachel. “But I think that there are a lot of moving pieces. There's a lot of activity that's going on, whether it's in the form of furloughs that companies are going through, whether it's restructuring activity or employee terminations, whether they're receiving government grants, whether they've abandoned property to reduce their real estate footprint, whether they have idle facilities, or whether they're modifying stock awards. There's a whole slew of activities that are not necessarily within their normal operations. Think about the modification of stock awards and issuing of new stock awards because the previous stock awards are no longer providing the incentives to employees that they were supposed to. Whether you’re abandoning properties, whether you have idle facilities, or you have employees on furloughs, employee severance and restructuring activities, debt modifications, lease modifications, new contract modifications, it's a very long list. Those are a lot of activities that a company wouldn't typically have going on simultaneously. That puts a lot of pressure on companies from a financial reporting and accounting standpoint because there are a lot of unusual transactions that a company needs to make sure that they're accounting for and reporting correctly.”
Companies may need to adjust their internal controls to adapt to all the abrupt changes in the way they’re doing business as a result of the pandemic.
“Internal controls are typically designed to deal with recurring types of transactions,” said Knachel. “When you start to have more of these one-off transactions, what's really happening is you have a change in operations, a change in the way the company is doing business. That's going to put pressure on what you need to change the design of controls and what kind of controls you have in place to deal with these one-off transactions. Companies need to be thinking about what to do with their internal controls as their business evolves.”