On June 23, 2020, the U.S. Securities and Exchange Commission’s Division of Corporation Finance issued Disclosure Guidance Topic No. 9A, providing additional views of the staff regarding operations, liquidity and capital resources disclosures that companies should consider with respect to business and market disruptions related to Coronavirus Disease 2019 (COVID-19). The guidance supplements Disclosure Guidance Topic No. 9 issued on March 25, 2020 discussed in our prior client alert found here.
The guidance notes that companies are undertaking a diverse range of operational adjustments in response to COVID-19, which may have an effect on the company that would be material to an investment or voting decision. The guidance indicates that affected companies should carefully consider their obligations to disclose that information to investors. In addition, companies are undertaking a diverse range of financing activities in response to COVID-19. The guidance indicates that companies should provide robust and transparent disclosure about their response to short- and long-term liquidity and funding risks in the current economic environment, as well as any new uncertainties related to those efforts. While the staff has observed companies making some of these disclosures in earnings releases, the staff encourages companies to consider whether any of these disclosures should also be included in MD&A.
By way of illustration, the staff encourages companies to consider a broad range of additional questions that are more specifically focused on the evolving impact of COVID-19 on their particular operations, liquidity and capital resources, including:
- Operational Challenges. What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? How and to what extent have you altered your operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace? How are the changes impacting or reasonably likely to impact your financial condition and short- and long-term liquidity?
- Liquidity Position and Outlook. 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 any decreases in cash flow from operations having a material impact on your liquidity position and outlook?
- Use of Lines of Credit and Capital Raising Activities. Have you accessed revolving lines of credit or raised capital in the public or private markets to address your liquidity needs? Are your disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of your financial condition and liquidity?
- Ability to Access Funding. Have COVID-19 related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods? Have you provided additional collateral, guarantees, or equity to obtain funding? Have there been material changes in your cost of capital? How has a change, or a potential change, to your credit rating impacted your ability to access funding? Do your financing arrangements contain terms that limit your ability to obtain additional funding? If so, is the uncertainty of additional funding reasonably likely to result in your liquidity decreasing in a way that would result in you being unable to maintain current operations?
- Covenant Compliance. Are you at material risk of not meeting covenants in your credit and other agreements?
- Use of Cash Metrics. 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? Are there estimates or assumptions underlying such metrics the disclosure of which is necessary for the metric not to be misleading?
- Changes in Capital Expenditures, Dividends and Business Operations. Have you reduced your capital expenditures and if so, how? Have you reduced or suspended share repurchase programs or dividend payments? Have you ceased any material business operations or disposed of a material asset or line of business? Have you materially reduced or increased your human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long do you expect to maintain them? What factors will you consider in deciding to extend or curtail these measures? What is the short- and long-term impact of these reductions on your ability to generate revenues and meet existing and future financial obligations?
- Debt Service Obligations. Are you able to timely service your debt and other obligations? Have you taken advantage of available payment deferrals, forbearance periods, or other concessions? What are those concessions and how long will they last? Do you foresee any liquidity challenges once those accommodations end?
- Contract Modifications. Have you altered terms with your customers, such as extended payment terms or refund periods, and if so, how have those actions materially affected your financial condition or liquidity? Did you provide concessions or modify terms of arrangements as a landlord or lender that will have a material impact? Have you modified other contractual arrangements in response to COVID-19 in such a way that the revised terms may materially impact your financial condition, liquidity, and capital resources?
- Supply Chain Financing Arrangements. Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and if so, how? What are the material terms of the arrangements? Did you or any of your subsidiaries provide guarantees related to these programs? Do you face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?
- Subsequent Events. Have you assessed the impact material events that occurred after the end of the reporting period, but before the financial statements were issued, have had or are reasonably likely to have on your liquidity and capital resources and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?
Government Assistance – The CARES Act
In addition, companies receiving federal assistance, such as assistance through the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), 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, including:
- Impact and Terms of Loans or Assistance. How does a loan impact your financial condition, liquidity and capital resources? What are the material terms and conditions of any assistance you received, and do you anticipate being able to comply with them? Do those terms and conditions limit your ability to seek other sources of financing or affect your cost of capital? Do you reasonably expect restrictions, such as maintaining certain employment levels, to have a material impact on your revenues or income from continuing operations or to cause a material change in the relationship between costs and revenues? Once any such restrictions lapse, do you expect to change your operations in a material way?
- Tax Relief. Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity? Do you expect a material tax refund for prior periods?
- Accounting Estimates. Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate? What accounting estimates were made, such as the probability a loan will be forgiven, and what uncertainties are involved in applying the related accounting guidance?
Ability to Continue as a Going Concern
Further, 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, management should provide appropriate disclosure in the financial statements and consider questions regarding the disclosure in MD&A, including:
- Analyzing Ability to Continue as a Going Concern. 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?
- Addressing Going Concern Challenges. What are your plans to address these challenges? Have you implemented any portion of those plans?
The staff continues to monitor company disclosures about the impact of COVID-19 and encourages companies to provide disclosure that allows investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively update disclosure as circumstances change. As was the case for the previous quarter’s reports, reporting for this quarter is likely to be more involved than the typical quarter. Companies should start the process early.
Statement by the Office of the Chief Accountant on COVID-19 Issues
Also on June 23, 2020, the SEC’s Office of the Chief Accountant (OCA) issued a public statement discussing the continued importance of high-quality financial reporting for investors in light of COVID-19. The public statement highlights some of the significant accounting, auditing and financial reporting issues recently addressed by the OCA and reiterates the disclosure considerations regarding an entity’s ability to continue as a going concern that were discussed in Disclosure Guidance Topic No. 9A. Chief Accountant Sagar Teotia also emphasized the importance of the role that audit committees play in the financial reporting system, noting that “[i]n these times of rapid change and increased uncertainty, the need for the oversight role that audit committees play is as critical as ever” to enhancing financial reporting.
The public statement also emphasizes the importance of robust internal accounting controls, reminding preparers that as they respond to the changing environment, they should consider whether any change to their financial reporting processes materially affects, or is reasonably likely to materially affect, an entity’s internal control over financial reporting, and if so, to disclose such change.
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