Second-quarter reporting is when most companies will have to deal with the significant impacts of the coronavirus on their current financial reporting and the uncertainty about its future effects. The pandemic has resulted in conditions that frequently occur during economic downturns, including closures, layoffs, reduced demand, and liquidity issues.
But it has also caused unusual changes, including how and where employees work, financial market volatility, customers’ social distancing, and government intervention. Now is the time to consider how to reflect these items in the reporting of non-GAAP measures.
The rules around non-GAAP reporting have not changed. Eric Knachel, senior consultation partner at Deloitte’s National Office - Accounting and Reporting Services, discussed the non-GAAP framework and how COVID-19 introduces new considerations and challenges.
Guidance for public companies on non-GAAP reporting is included in Regulations G and S-K. “The three main principles are to present the most directly comparable GAAP measure with equal or greater prominence, provide a quantitative reconciliation between the relevant GAAP and non-GAAP measure, and include management’s explanation of why the non-GAAP measure provides useful information to investors,” Knachel said.
“The two big areas where I think we are going to see non-GAAP measures relating to COVID-19 are impairments and incremental costs,” he said.
Impairments may relate to goodwill, intangibles, other long-lived assets, or cost investments. Knachel noted changes in the levels of business and shutdowns from the coronavirus are reducing expected cash flows that can lead to asset impairments. In the past, the Securities and Exchange Commission has not objected to impairment charges being included in non-GAAP metrics.
The SEC also permits non-GAAP measures that adjust for unusual and incremental costs. “There are two categories of COVID-related incremental costs,” Knachel said. “One is items like additional supplies, cleaning, changing the office space layout, and buying employees laptops for working at home. The second broad category is restructuring costs, including employee terminations, exit, closure, and disposal costs.” Knachel noted restructuring costs are fairly common in non-GAAP measures the SEC has accepted before, and if COVID-19 is causing the restructuring costs, the SEC will likely consider adjusting for them acceptable.
“In their non-GAAP guidance, the SEC objects to removing recurring cash operating costs, even if they are not generating revenues,” Knachel said. “When a company is evaluating costs, they need to think about whether they are directly related to COVID-19 and whether they represent nonrecurring costs. Their initial reaction may be that if it’s a cost they have not historically had, it should be a non-GAAP adjustment because it is not a normal recurring cost, but then there will likely be a pause.”
In Knachel’s opinion, the most challenging aspect of non-GAAP measures for COVID-19 is deciding what is a normal cost and what is not and determining whether a cost you have now that you did not have in the past will be incurred again for the foreseeable future because of the coronavirus.
Some portion of the COVID-19 cost may become a recurring cash cost. “There is significant judgment around what is not normal versus what is the new normal,” Knachel said. “And it is a moving target, because who really knows.” He cited the following examples:
- Providing employees with specialized equipment, depending on the industry;
- Monitoring costs related to building access, checking employees entering and exiting, and the cost of additional required personnel and new policies and procedures; and
- Employee healthcare costs, including self-insurance, and costs for sanitizing and other safety measures to protect employees.
Adjustments for lost revenues or profits are not permissible non-GAAP measures. Knachel noted many companies are receiving government grants under the CARES Act and insurance recoveries relating to COVID-19 and sees these as potential non-GAAP items. “These will be interesting because a lot of times when you think of non-GAAP adjustments you think of excluding bad things, but these are additional income items that are not normal,” he said. “Companies may view these as making up for revenues they would have otherwise had.”
Companies likely have existing controls in place relating to non-GAAP reporting. “What is different is the increased importance and emphasis of these controls because what is normal is changing,” Knachel said. “The environment we are in is putting more pressure on the controls, and it is a different landscape for evaluating non-GAAP items.”
Additional guidance about financial reporting trends relating to COVID-19 including non-GAAP are available in Deloitte’s Accounting Research Tool. Also, the SEC view on disclosures companies should consider is in its March 2020 Disclosure Guidance: Topic No. 9.