The end of 2020 is on the horizon, and auditors at calendar-year companies are already planning and beginning their audits. The usual annual challenges of implementation of new accounting standards and related internal controls persist, but this year-end is unlike any other, as firms are dealing with changes to their businesses and the economy overall as a result of the COVID-19 pandemic.
New Financial Accounting Standards Board (FASB) Chair Richard Jones discussed the challenges he faces in his role and the organization’s priorities in this environment at the recent FEI Corporate Financial Reporting Insights Virtual Conference. Jones started his term as chair as the pandemic was beginning and expected hurdles but did not envision having to deal with the challenges of standard-setting during COVID-19.
“Stakeholders are all in a challenging environment,” he said. “Our first focus is on emerging critical issues coming out of the current environment.”
Jones acknowledged there are three major standards currently being adopted—revenue, leases, and CECL—and the “change fatigue” that comes along with that. FASB has delayed and phased in effective dates in response to the pandemic to get higher-quality adoption and is watching the impact of the current economic environment on CECL implementation. “In general, as we move ahead with our regular agenda, we may make exposure periods longer and assess the implementation dates,” Jones said.
Hillary Salo, FASB’s recently appointed technical director, commented on the importance of stakeholder input and communication for high-quality adoption of accounting standards. She said FASB will continue to improve its outreach to stakeholders, including regulators, because their input is critical to the quality of accounting standards. FASB has provided interpretative guidance in the form of Q&As on topics like leasing, hedging, and CECL and has created a COVID-19 portal on its Website in response to stakeholder needs and concerns.
Can’t let pandemic impact audit quality
The pandemic has changed the way companies and their auditors work, with remote working now the norm, even for regulators. At the conference, Duane DesParte of the Public Company Accounting Oversight Board said he expects audits may take more time this year because changes in the working environment have added complexities, but the focus must continue to be on high-quality audits that comply fully with standards for objectivity and professional skepticism.
DesParte discussed the importance of risk assessment by management and auditors to address changes in business processes and controls and increased fraud risk as a result of economic pressures and personnel changes. He recommends auditors talk to management and audit committees more often and in more detail about these potential risks.
For many companies, new standards on revenue, leases, and credit losses continue to be a priority for year-end accounting and reporting and beyond. In June, FASB deferred the effective dates for certain entities for revenue and leases as a result of the pandemic.
- Topic 606 on revenue recognition is effective for all entities who had not issued financial statements before the date of the deferral for annual reporting periods beginning after Dec. 15, 2019, which is 2020 year-end for many calendar-year companies.
- Topic 842 on leases is effective for companies other than public companies for fiscal years beginning after Dec. 15, 2021.
Topic 326 on credit losses is effective for public business entities for fiscal years beginning after Dec. 15, 2019, but was previously deferred in November 2019 for all other entities until fiscal years beginning after Dec. 15, 2022. CECL compliance was delayed for the year in March as part of the coronavirus relief package (CARES Act) passed by Congress.
Things to consider in year-end audits
In addition to these standards, there were a number of other accounting hot topics discussed at the conference that have come to the forefront this year-end because of COVID-19:
Going concern. Many more companies will face potential going concern issues than in a typical year. There are both financial reporting and auditing requirements for going concern affecting year-end reporting. Management must evaluate whether conditions and events, considered in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued or available to be issued. This includes assessing whether it is probable the entity would not be able to meet its obligations when they become due.
In making this evaluation, companies need to consider company-specific issues and assumptions along with those of their industries and the domestic and international economies overall. Many companies have never considered going concern risks before and may not have processes in place to do this assessment. Forecasting cash flows is essential to this analysis, so a company’s ability to forecast in an uncertain environment and to obtain reliable and auditable data both from inside the company and from third parties is critical.
Impairment. Both tangible and intangible assets must be evaluated for potential impairment indicators. Because of the rapidly changing economic environment, these indicators may be different today than they will be at year-end and there may need to be several assessments. Intangible assets required to have an annual impairment test may also have to be tested for impairment when certain triggering events occur. The ability to forecast future cash flows is a key part of the impairment analysis, so the challenges noted above for going concern are relevant in this area as well.
Estimates. Many accounting standards require the use of estimates and forward-looking information, and the quality of the estimates depends on availability and reliability of the information used. The way management has estimated in the past based on historical experience may not work in the current environment. It is also difficult to determine what companies’ “new normal” will be in the near-term and future years, especially if they have had changes to customers, supply chain, or product and service offerings, and whether they will ever return to pre-COVID results. Some companies planning to use the 2008 financial crisis as a benchmark may need to reevaluate their approach, because that time may not be relevant to what is happening today. It may be necessary to create multiple scenarios and weigh the potential outcomes. There may be a need to use third-party data.
Fair values of investments. Financial assets, including debt and equity securities; loans and receivables; and equity method investments all may have declined in value or become impaired as a result of current economic conditions. Companies must assess fair values based on the requirements of the various accounting standards that apply by type of investment and ensure they have reliable and auditable data to support their judgments.
Government assistance. Financial assistance in response to the pandemic provided by the CARES Act and Paycheck Protection Program loans adds new complexity to year-end accounting and disclosure for certain entities. Many companies have never received aid before and do not have an accounting policy for it. The rules have been evolving, and different accounting frameworks apply in different circumstances based on the form and substance of the assistance, such as whether the financial aid is in the form of a tax credit or grant. Companies may account for the funds received as either debt or a grant, with different risks and judgments. In addition to getting the new accounting and disclosures right, companies need to comply with the provisions of the Act to avoid enforcement actions. Government assistance can have an impact on a company’s going concern analysis.
Modifications to contractual arrangements. The pandemic and liquidity issues have caused many companies to amend existing contracts. Debt agreements may have revised terms, including interest rates, timing of payments, and debt covenants. These can result in different accounting and disclosure requirements as either a debt modification or extinguishment. Lease agreements may also have been modified, with specific accounting requirements under the lease standards. Normal operating contracts with customers, vendors, suppliers, and service providers all need to be considered and reviewed for areas where noncompliance can have accounting or disclosure implications, including potential contingent liabilities and going concern.
Subsequent events. Companies must evaluate and consider the need for accounting and disclosure of both recognized and non-recognized events occurring after the balance sheet date but before the financial statements are issued or available to be issued. While this is always a requirement, COVID-19 is causing changing situations around the world on an almost-daily basis. Each company needs to continue to evaluate relevant facts and circumstances to conclude whether there are impacts on management’s estimates and judgments in all areas of its financial statements, including the topics noted above. Because each company is impacted differently, its subsequent events disclosures need to be tailored.
Ten things I’d like to see happen in 2021 (2020 in review)
- Currently reading
Things to consider for companies preparing for 2020 year-end audits