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Company Pandemic-Related Financial Statement Transactions
After spending the past year wrestling with the financial impacts of the COVID-19 pandemic, companies that are required to prepare audited financial statements must now address a new challenge: deciding how to report and disclose certain pandemic-related transactions and risks on their financial statements.
Financial officers will need to work closely with their auditors to prepare statements that auditors can endorse without qualification. Here are several areas that merit special attention.
The frequently changing forgiveness provisions of the Paycheck Protection Program (PPP) have raised numerous financial statement questions, particularly for companies that have met the requirements for PPP loan forgiveness but have not yet submitted forgiveness applications or are waiting for approval.
Companies may use one of four models to account for such loans. Three of these are part of the U.S. Financial Accounting Standards Board’s Accounting Standards Codification (FASB ASC), while the fourth is recognized by the International Accounting Standards Board:
1. Debt Model (FASB ASC 470) – In this model, a PPP loan is accounted for like any other liability (including interest accrual) until the forgiveness process is completed and the company is legally released. At that point, the forgiveness is recorded as other income (specifically, a “gain on PPP loan extinguishment”) and the liability is removed.
2. Gain Contingency Model (FASB ASC 450-30)– As with the debt model, the loan is initially accounted for as a liability, but in this model the liability can be removed before the loan is forgiven, provided all uncertainties regarding forgiveness have been resolved.
3. Government Grant Model (FASB ASC 958-605)– In this model, the loan is recorded as a liability (a “deferred PPP grant”). As the company uses the proceeds to pay eligible expenses (such as payroll, rent, or utilities), the liability is gradually reduced and the proceeds are recorded as PPP grant income.
4. International Accounting Standards Model (IAS 20)– This method allows for the liability to be removed even earlier than the FASB models because it relies on management’s projection of the likelihood it will meet the PPP forgiveness conditions.
The debt model is the least risky of these methods. The other models involve some degree of risk because they depend on the company’s judgment that the loan will be forgiven. Regardless of which model a company uses, its financial statements should include a footnote disclosing the method and the current status of its forgiveness application.
Going Concern Disclosures
Financial reporting standards require management to disclose any factors that could call into question the entity’s ability to continue as a going concern for one year after the date the financials are issued. Potential adverse indicators could range from negative financial trends such as recurring operating losses, working capital deficiencies, or negative cash flows to external risks such as work stoppages or customer defaults.
The audit team is responsible for reviewing management’s going concern disclosures and evaluating whether the company’s plans to address these risks are adequate and can be effectively implemented. Management should collaborate with the audit team to address any going concern issues.
Other Footnotes and Disclosures
Several other commonly required financial statement disclosures also merit particular attention in the pandemic era. For example, management must disclose any significant “subsequent events.” These are events that occur after the closing date for the financial statements (typically December 31) but before the statements are published (often several months later).
The pandemic makes it more likely that companies will encounter subsequent events that could have a serious impact on their financial condition and risk profiles. Management should prepare financial statement footnotes that disclose such events and their estimated impact.
Another commonly required disclosure involves “risks and uncertainties”—issues that could significantly affect reported amounts on financial statements or the near-term functioning of the company. The COVID-19 pandemic has generated numerous uncertainties including shutdown mandates, jobsite restrictions, and other external factors that could affect a company’s major customers, suppliers, lenders, workers, or other stakeholders.
In these and all other areas, clear communication and management transparency are important for auditors to provide an unqualified or “clean” audit opinion without adverse modifications.
The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.