COVID-19’s Impact on Your Financial Statements

COVID-19’s Impact on Your Financial Statements

The COVID-19 pandemic has been a roller coaster for almost everyone, personally and professionally, and remains a rapidly evolving situation. Due to the fast-changing business environment, unprecedented market volatility and other circumstances resulting from the pandemic, many companies are uncertain of the full extent of COVID-19’s impact on their business’ future—and the preparation of their financial statements. The following are some key factors that should be considered when preparing your most recent year-end financial statements.

  • Accounts Receivable: Customers’ accounts receivable balances are uncharacteristically becoming more aged as they are unable to make payments based on the terms previously agreed to. The real estate industry has experienced significant collectability concerns as well, often resulting in larger than normal tenant receivable balances. It is critical to review tenant accounts receivable to determine the collectability of such balances. Prior to COVID-19, your estimate of collectability could have been viewed as part of normal operations. However, with an increase in accounts receivable balances, this estimate could be considered a significant estimate and be a required matter of footnote disclosure.

  • Going Concern and Liquidity: Substantial doubt about continuing as a going concern can arise as a result of the current market situation, including working capital deficiencies, cash flow deficits from operations, inability to refinance existing debt or failure to meet certain financial covenants, along with changes in deferred taxes and their valuation allowance. Businesses with high payables that are unable to make rent payments may find themselves in liquidity trouble. Such concerns arise from a decrease in customer base, which ultimately leads to a decrease in sales, significant vacancy, termination of lease agreements or increased costs due to COVID-19. These concerns may raise substantial doubt that a company can continue as a going concern. It is important to remember that the evaluation of a company’s ability to continue as a going concern is measured one year from the date the financial statements are issued. If one of the aforementioned indicators is present, disclosure in the financial statements is required. Robust disclosure will allow users of the financial statements to understand the economics of the business and management’s plan to alleviate any substantial doubt going forward.

  • Inventory: Several issues arise when considering the impact of COVID-19 as it relates to inventory.  Companies need to consider supply shortages and travel restrictions when procuring inventory.  On the flip side, obsolescence is another concern if demand for a company’s product declines, if the company is unable to ship product due to travel restrictions or if the company’s customers own or operate retail stores where foot traffic has significantly declined.  In addition, if a company is required to produce audited financial statements, one of the audit requirements is the observation of inventory by their auditors. This can be challenging due to social distancing requirements.  Companies and their auditors should consider performing the observations through virtual means (e.g., the use of video cameras or other video-capturing devices) or performing observations with a limited number of personnel, which makes social distancing easier. 

  • Impairment: U.S. GAAP requires that long-lived assets be reviewed for impairment if events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. An impairment loss may be recognized when undiscounted future cash flows expected to result from the use of the asset, including disposition, are less than the carrying value of the asset. While real estate assets have historically been appreciating, they are deemed to be depreciating assets for accounting purposes. The COVID-19 environment has put unprecedented pressure on the real estate market, resulting in the potential for the carrying value of your real estate assets to be greater than the fair value of such assets. Fair value is determined using discounted cash flows, quoted market prices or external appraisals.

  • Contingencies and Uncertainty:  The COVID-19 environment’s general uncertainty is a matter of disclosure. The extent of the impact of COVID-19 on business and financial results will depend on future developments, including the duration and spread of the outbreak.  Performance in future periods will be heavily influenced by the timing, length and intensity of the economic recovery in the United States. To provide increased transparency to financial statement users, the organization’s plans to continue to monitor evolving economic and general business conditions and the actual and potential impacts on its financial position and results of operations should be included in the financial statement footnotes.

  • Lease Accounting: Many landlords will have given lease concessions during 2020, which are continuing into 2021, in the form of rent deferrals and abatements, particularly with commercial tenants. These lease concessions and the method for which the organization is accounting for them is a required matter of disclosure. As an attempt to provide relief of financial reporting burdens, the Financial Accounting Standards Board (FASB) has provided guidance in this area. Companies have the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease. This election is only available when total cash flows resulting from the modified lease are substantially similar to the cash flows in the original lease. When this election is made, the lease concession will be accounted for as a lease modification, in a prospective manner. When total cash flows resulting from the modified lease are not substantially similar to the cash flows in the original lease, management accounts for the concession agreement as a new lease.

  • SBA Paycheck Protection Program Loans: Many companies were able to obtain Paycheck Protection Program (PPP) loans to assist them in the economic downturn resulting from COVID-19. The availability of a second PPP loan (PPP2) may provide companies some additional relief. Most real estate was not eligible for the first round of PPP funding; however, some classifications of real estate are now eligible for PPP funding. If you have applied for and/or received PPP funding, the terms of the loan and method for which it is accounted for will need to be disclosed in your financial statements, along with the current status of the company’s loan forgiveness process.  Applicable disclosure will need to be made for those that applied/received PPP2 funds.

Please contact Darya Shneyder, Partner in Marks Paneth’s Real Estate Group, if you have any questions on this issue. Contributing to this article were Erin Kiernan, Senior Manager in the Real Estate Group, and Matthew Hausman, Manager in the Real Estate Group.