Accounting at the time of Covid-19: Disclosure quality as leading indicator

The SEC issued a public statement Wednesday April 8, emphasizing the importance of forward looking disclosures by public companies due to accounting implications arising out of Covid-19. It went so far as to say that “this quarter, earnings statements and calls will not be routine. In many cases, historical information may be substantially less relevant". This underlines how much (or how little) is known about the pervasive and as yet unfathomable economic implications of the crisis. At best, this can be partially mitigated through the use of non-boilerplate, specific and substantive disclosures on operating and financial dislocations (actual and anticipated) in quarterly earnings releases “under various COVID-19-related mitigation conditions”. Regulatory expectation suggests that there will be at least some disclosures driven by modelling and scenario analysis. Also, there is clear regulatory emphasis on disclosures related to liquidity and the ability to remain a going concern. The SEC statement neatly rounded off sentiments underlining the more detailed guidance issued a fortnight earlier by it on its expectations regarding material disclosures arising from assessments relating to going concern, fair valuation, non-financial asset impairments and, a detailed discussion on reconciling non-GAAP earnings to (potentially uncertain!) preliminary GAAP estimates in earnings releases.

Counter-intuitively, because GAAP numbers are likely to include a number of (highly) uncertain estimates and judgements particularly in the measurements of assets and revenue recognition arising from Covid-19, the effect of backing out some of these may appear to give higher legitimacy and definiteness to non-GAAP numbers, which in turn, may be open to abuse. Opportunistically reporting favourable ‘adjusted’ EBITDA numbers to suggest that these are more definite, or related to core/continuing earnings may be misleading given the likely magnitude and enduring effects of the current crisis. The SEC guidance emphasises that in such cases additional disclosures will be needed regarding the justification for using specific non-GAAP performance measures. Elsewhere in Europe, learnings from this extraordinary situation may well help shape feedback and direction on ‘Non-GAAP transparency’ within the IASB’s proposed standard on General Presentation and Disclosures (Primary Financial Statements), which is currently open for feedback until 30^th June, 2020.

Elsewhere, the UK market regulator has issued directions to London-listed issuers to delay issuing preliminary results ahead of publishing full year 2019 financials to prevent a scenario where accelerated and (often) unaudited full year earnings releases may potentially mislead or put undue pressures on companies’ financial reporting infrastructures. The FRC has also issued a statement clarifying that for financial statements ending December 31, 2019, most adjustments to balance sheet carrying values are likely non-adjusting events, given the emergent state of the crisis at that point. Nevertheless, as Q1 2020 revenue numbers begin trickling in and even otherwise under separate reporting obligations, a discussion of material impacts to operating and financial outlook is expected to be released by UK listed entities in the upcoming weeks and months.

As market regulators world-wide respond with extension of deadlines for reporting annual and quarterly numbers, the timing and trajectory of the crisis has specific and widespread financial reporting implications. For December year end/Quarter end, Covid-19 is largely interpreted as giving rise to non-adjusting events (events occurring after balance sheet date, that do not require an adjustment to recognition/measurement as on Balance Sheet date). However as of March quarter end for companies across the globe, and full FY 2019-20 year-end for Indian companies, one cannot simply interpret Covid-19 as an event occurring after Balance Sheet date leave alone, ignore considering the effects on recognition/measurement as on 31/3. Each development and its associated impact on an account/set of accounts will need to be evaluated separately as an adjusting or non-adjusting event depending on the nature of the event, specific circumstances and type of account impacted. Quite apart from these considerations, there are other significant developments. Some relate to the suspension of specific GAAP requirements considered onerous in crisis-time e.g. in the US through the statutory suspension of FASB requirements related to Continuous Expected Credit Losses (i.e. CECL or loan loss reserving based on life time anticipated losses) applicable to depository /banking institutions at least until the end of the current emergency. This is a throwback to the temporary suspension of fair value measurement requirements at the time of the global financial crisis over a decade ago. Others relate to additional guidance in applying specific standards e.g. IFRS 9 and IFRS 16 (leases) issued last week by the IASB. Or more sweeping guidance such as that issued in India by the ICAI. Finally, the pandemic is also compelling standard-setters to reconsider their project timelines and due-process feedback deadlines. The IASB has already announced its intention to take further action in this regard.

This is a time of significant measurement uncertainty. Disclosure quality will serve as a leading indicator of the nature and magnitude of this uncertainty that will eventually crystallise as it washes through income statements and balance sheets in the next several quarters. Standard-setters may well have to build a repository of learnings for future template-building. Meanwhile as the economic effects of Covid-19 unfold, specific standards and guidance may also have to be re-looked at in new light. More on these in subsequent blog posts.

The opinions expressed are solely those of the author.