The SEC’s Division of Corporation Finance (Division) has issued disclosure guidance in the form of CF Disclosure Guidance: Topic No. 9A addressing COVID-19 disclosure considerations regarding operations, liquidity and capital resources. The Guidance supplements CF Disclosure Guidance Topic 9 which provided the Division’s initial views on disclosure and other securities law obligations that companies should consider with respect to COVID-19 and related business and market disruptions.
In addition, the SEC’s Office of the Chief Accountant (OCA) issued a statement via its Chief Accountant, Sagar Teotia, regarding the continued importance of high-quality financial reporting in light of the significant impacts of COVID-19. OCA notes many public companies are now preparing for their next reporting cycle (e.g., second quarter financial reporting), and emphasizes that participants in the financial reporting system continue to play an important role in the functioning of our markets and in the collective national effort to mitigate the COVID-19 pandemic.
CF Disclosure Guidance: Topic No. 9A – COVID-19 Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources
The Division continues to encourage companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change. These disclosures should enable an investor to understand how management and the Board of Directors are analyzing the current and expected impact of COVID-19 on the company’s operations and financial conditions, including liquidity and capital resources.
Operations, Liquidity, and Capital Resources
The Division notes companies have undertaken and are generally in the process of making a diverse range of operational adjustments in response to the effects of COVID-19. These adjustments are numerous and include a transition to telework; supply chain and distribution adjustments; and suspension or modification of certain operations to comply with health and safety guidelines to protect employees, contractors, and customers, including in connection with a transition back to the workplace. According to the Division, it is important that companies provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties to their businesses. While the Division has observed companies making some of these disclosures in their earnings releases, the guidance encourages companies to evaluate whether any of the information, in light of its potential materiality, should also be included in MD&A.
Much of CF Disclosure Topic 9A is comprised of a list of questions for companies to consider when formulating disclosures, such as:
- What are the material operational challenges that management and the Board of Directors are monitoring and evaluating?
- How is your overall liquidity position and outlook evolving? To the extent COVID-19 is adversely impacting your revenues, consider whether such impacts are material to your sources and uses of funds, as well as the materiality of any assumptions you make about the magnitude and duration of COVID-19’s impact on your revenues.
- Are you at material risk of not meeting covenants in your credit and other agreements?
- If you include metrics, such as cash burn rate or daily cash use, in your disclosures, are you providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity?
Government Assistance – The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
The Division notes the CARES Act includes financial assistance for companies in the form of loans and tax relief in the form of deferred or reduced payments and potential refunds. 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. Questions to consider include:
- How does a loan impact your financial condition, liquidity and capital resources?
- Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity?
- Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate?
A Company’s Ability to Continue as a Going Concern
The Division’s guidance reminds management to consider whether 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 financial statements. Where there is substantial doubt about a company’s ability to continue as a going concern or the substantial doubt is alleviated by management’s plans, the Division notes that management should provide the appropriate respective disclosures in the financial statements and consider the following questions regarding the 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, have you defaulted on outstanding obligations? Have you faced labor challenges or a work stoppage?
- What are your plans to address these challenges? Have you implemented any portion of those plans?
OCA Statement on Continued Importance of High-Quality Financial Reporting
Highlights of the OCA’s statement are set forth below.
Significant Estimates and Judgments; Reasonable Judgments
As noted in previous guidance, the OCA’s statement emphasizes that in connection with financial reporting responsibilities, many companies have been required to make significant judgments and estimates to address a variety of accounting and financial reporting matters. According to the statement, OCA has consistently not objected to well-reasoned judgments that entities have made, and OCA will continue to apply this perspective. 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.
The Importance of Disclosure Controls and Procedures (DCP) and Internal Control over Financial Reporting (ICFR)
OCA continues to emphasize the importance of robust internal accounting controls to high-quality, reliable financial reporting. Public companies are required to maintain DCP and ICFR. In addition, management is required to evaluate the effectiveness of a public company’s DCP as of the end of each fiscal quarter, and the effectiveness of its ICFR at the end of each fiscal year. OCA understands preparers have adapted, or are adapting, their financial reporting processes as they respond to the changing environment. These changes may include consideration on how controls operate or can be tested and if there is any change in the risk of the control not operating effectively in a telework environment. In addition, changes to the business and additional uncertainties may result in additional risks of material misstatement to the financial statements in which new or enhanced controls may need to be implemented to mitigate such risks. OCA reminds preparers that if any change materially affects, or is reasonably likely to materially affect, an entity’s ICFR, such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred.
Reminders about an Entity’s Ability to Continue as a Going Concern
Financial reporting pursuant to U.S. generally accepted accounting principles (GAAP) presumes a reporting entity has the ability to continue as a going concern. OCA reminds preparers that in each reporting period, including interim periods, management should consider whether relevant conditions and events, taken as a whole, raise substantial doubt about the entity’s ability to meet its obligations as they become due within one year after the issuance of the financial statements. In instances where substantial doubt about an entity’s ability to continue as a going concern exists, management should consider whether its plans alleviate such substantial doubt, and make appropriate disclosures to inform investors. Such disclosures should include information about the principal conditions giving rise to the substantial doubt, management’s evaluation of the significance of those conditions relative to the entity’s ability to meet its obligations, and management’s plans to alleviate substantial doubt. If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is not alleviated, additional disclosure is required. OCA notes that GAAP requires such disclosure in the notes of the financial statements and this may be incremental to other disclosure requirements in filings with the Commission.
In addition, the statement notes auditors also have responsibility to evaluate an entity’s ability to continue as a going concern based on their knowledge of relevant conditions that exist at or occurred prior to the date of the auditor’s report. Although a 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, an auditor may become aware of such conditions or events in the course of performing review procedures. In such cases, auditors should inquire with management and consider the adequacy of the relevant disclosures’ conformity with GAAP. OCA reminds auditors that after performing such procedures, to the extent the auditor determines the relevant disclosure is inadequate such that it represents a departure from GAAP, the auditor should extend the procedures, evaluate the results and communicate as appropriate with the issuer and its audit committee.
Engagement with and the Vital Role of Audit Committees
The statement notes OCA has stressed many times in the past the key role that audit committees of companies play in the financial reporting system through their oversight of financial reporting, including ICFR and the external, independent audit process. The statement reiterates OCA’s strong belief that the measures related to audit committees have proven to be some of the most effective financial reporting enhancements included in the Sarbanes-Oxley Act.
In these times of rapid change and increased uncertainty, OCA believes the need for the oversight role that audit committees play is as critical as ever. The statement also highlights OCA’s view that the most effective audit committees are engaged, executing their responsibilities with diligence, and this engagement significantly enhances the financial reporting output.
