Audit Analytics has just released a deep dive into the impact of COVID-19 on financial reporting and financial wellbeing. To assess the effect of the pandemic, the report looked at going-concern audit opinions, impairment charges, late filings and changes in the control environment, as well as restatements. Some of the results might be surprising. For example, the pandemic had a significant impact on impairment charges, but the number of going-concern qualifications in audit opinions? Not so much.
Going-concern opinions. Surprisingly, given the uncertainties created by COVID-19 and the risk of economic instability, Audit Analytics found that, based on going-concern trends since 2015, "COVID-19 had no discernable impact on the overall amount of going concern audit opinions issued for fiscal year 2019." In addition, based on current data, "it appears 2020 will have a significant decrease in going concerns." Audit Analytics interprets the relative stability in the percentage of going-concern audit opinions to suggest "that public companies did not anticipate the impacts from COVID-19 to have adverse long-term effects on financial health."
By company size, Audit Analytics found that, in 2019, "Large Accelerated Filers experienced a modest increase in the amount of going concern opinions, while going concerns for Accelerated Filers and Smaller Reporting Companies decreased in 2019." By industry, there were increases in going-concern opinions in 2019 and 2020 in three industries "that heavily rely on future estimates to gauge financial health: Construction, Wholesale Trade, and Finance, Insurance and Real Estate. This suggests that, for most industries, any immediate impacts of COVID-19 on financial health were not expected to have long-term substantial impacts that would continue to deteriorate financial position."
In 2020, companies in the services, agriculture, manufacturing, mining, wholesale trade and retail industries showed a decrease in the percentages of going-concern audit opinions. Were these improvements the result of a high company disappearance rate, such as through bankruptcies? Apparently not. According to the report, the number of "clean" opinions actually increased, and new going-concern opinions decreased. In addition, the number of companies that had received a going-concern opinion and subsequently disappeared remained stable in 2019 and decreased in 2020.
One aspect of new going-concern opinions identified by Audit Analytics that did change was the increased incidence of issues related to debt covenants and notes payable/debt maturity, which, in 2019 and 2020, increased to be the fifth and sixth most common issue, compared to tenth and eleventh most commonly cited issues during the period between 2015 and 2020. In 2020, insufficient cash/liquidity issues also became more significant, rising from fifth place to be the second most common issue. Audit Analytics observed that "these factors heightened the risk for more significant impacts on a company's financial condition, regardless of previous financial health. The failure to meet debt covenant obligations and obtain financing was a significant risk during the pandemic due to the economic downturn and the uncertainty regarding the magnitude and timeline. For previously financially healthy companies that carried substantial debt covenant obligations pre-pandemic, COVID-19's impact on their financial position heightened the risk of failing to make required payments or violating agreements."
Impairments. Audit Analytics found that the volatility and uncertainty associated with COVID-19 had a significant impact on asset valuation, contributing to a "staggering $518 billion in total impairments disclosed in 2020," almost doubling the total disclosed in 2019. According to the report, charges related to property, plant and equipment (the other PPE) were especially costly. The report indicates increases in the number of impairments disclosed, the number of companies disclosing them, and aggregate charges. The impact was greater on smaller companies. Audit Analytics explained that the
"deteriorating macroeconomic factors during the pandemic, and associated declines in equity value, served as a triggering event for many companies, necessitating an interim impairment assessment to determine if assets were being overvalued. This confluence of conditions during the pandemic served as a catalyst for impairments. The prevalence of triggered assessments, in addition to rote assessments, manifested a substantial number of disclosed impairments in both 2019 and 2020. Notably, the financial impacts of these write-downs exploded in 2020, nearly doubling 2019's aggregate impact and far surpassing the annual impairment totals disclosed in the previous five years. In the case of very large write-downs, the need for a permanent adjustment to accurately reflect the underlying value of assets in response to the COVID-19 pandemic suggests that some of the changes were already needed. For example, if an asset needs to be impaired primarily due to destabilized estimates, it could be an indication the impairment is a result of ongoing problems at the company."
U.S. companies accounted for 80% of disclosed impairment charges in 2020 ($418 billion), compared with foreign companies ($102 billion). Companies of all sizes were affected, although, according to the report, several "massive impairment" charges taken by large companies led (in part) to a significant increase in aggregate impairment charges for large accelerated filers; nevertheless, smaller companies with fewer resources and less robust control systems, the report concluded, continue to be "at a higher risk for impairments with the potential to cause long-term damage to their financial health." In 2020, disclosure of impairments increased by 35% among non-accelerated filers and smaller reporting companies.
Shifting trends during the pandemic, which may or may not prove to be long-lasting, also affected impairments. For example, retail disclosed an aggregate of $270.6 billion in impairments (for example, closure of physical retail locations) and services disclosed an aggregate of $195 billion. Audit Analytics found that the pandemic made estimates and forecasts underlying the valuation of long-held assets more complex, "in some cases substantially shifting long-held future expectations. Predictably, impairments related to property, plant, and equipment (PPE) became more costly in 2020, as the valuation of these assets are particularly sensitive to estimates of future pricing/utility."
Late filings. Audit Analytics concluded that late filings increased "as many companies opted to take advantage of SEC relief; however, the number of days companies actually required to file their late reports remained the same." The timing of the pandemic, together with travel restrictions and the need for many to WFH, made the usual financial closing process more complex, leading many companies to miss filing deadlines. Many companies took advantage of conditional relief from the SEC in Q1 2020. "As anticipated," Audit Analytics found, "COVID-19 contributed to an increased number of late filings for 2019 reports. This reversed a four-year trend of public companies improving their ability to deliver timely information." Notably, COVID-19 had an earlier impact on timeliness for companies headquartered in foreign countries-a "51% increase in late filings for Q4 2019 and a 41% increase for Q1 2020. In comparison, US companies had an 11% increase for Q4 2019 and a 56% increase for Q1 2020." After Q1 2020, late filings decreased until Q1 2021, which "saw an increase in the number of late filings and a year-over-year positive change, though this increase was largely unrelated to pandemic impacts."
To address potential compliance issues arising out of challenges presented by the pandemic, the SEC issued an order that provided "publicly traded companies with an additional 45 days to file certain disclosure reports that would otherwise have been due between March 1 and April 30, 2020." Of course, there were conditions to satisfy. Most important, the companies had to be unable to file timely due to circumstances related to the coronavirus, and the companies had to submit Forms 8-K or 6-K, by the later of March 16 or the original reporting deadline, summarizing, among other things, "why the relief is needed in their particular circumstances." Timely filing could have been impeded by, for example, "[d]isruptions to transportation, and limited access to facilities, support staff, and professional advisors as a result of COVID-19." The SEC subsequently did extend the time period during which this relief applied. The SEC cautioned, however, that companies had to "continue to evaluate their obligations to make materially accurate and complete disclosures in accordance with the federal securities laws." (See this PubCo post.)
Companies that took advantage of SEC relief in both Q4 2019 and Q1 2020 were primarily (60%) in the manufacturing industry, where "companies with widespread or global operations were particularly affected by COVID-19 restrictions and supply chain disruptions," and in the services industry, where operations were often closed or suspended "due to pandemic lockdowns for non-essential services."
Controls. Audit Analytics reported that over 800 companies disclosed pandemic-related changes to their control environments. The pandemic precipitated a number of rapid operational adjustments related to personnel, transitions to remote work, travel restrictions, remote operating procedures and other disruptions of normal processes, many of which affected the ability to conduct physical processes. For example, companies may have had difficulty counting physical inventory or adequately segregating accounting responsibilities. These changes increase "the risk for material weaknesses in controls, while simultaneously inhibiting remediation efforts." In June 2020, the Office of the Chief Accountant issued a statement emphasizing, in light of COVID-19, the importance of disclosing changes regarding disclosure controls and procedures and internal control over financial reporting. Between Q1 2020 and Q1 2021, the report indicates, most (>2/3) of the control change disclosures related to personnel, while changes related to "information technology were a distant second." Most changes were disclosed during Q2 and Q3 2020, according to Audit Analytics, "reflecting a need for ongoing adjustments in light of the dynamic circumstances." Audit Analytics advises that cybersecurity controls will be particularly important going forward, as more work is being conducted remotely, online and through cloud services.
In June 2020, Sagar Teotia, then-SEC Chief Accountant, issued a Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19. One consequence of COVID-19, he said, was the pervasive transition to teleworking where possible, which inevitably affected companies' ability to monitor and test their ICFR. Teotia observed that companies had to consider how their adaptation to teleworking affected the operation and testing of their controls, including the risk that their controls may not operate as effectively when the workforce was working from home. In addition, Teotia noted that other business changes and uncertainties could increase the risk of misstatements, prompting a need for new or enhanced controls-and related disclosure in periodic reports about those changes in controls. (See this PubCo post.)
Restatements/enforcement. Audit Analytics suggests that rapid changes in personnel and company operations resulting from the pandemic may increase the risk for restatements, as issues may come to light in the next few years. However, the report indicates that, as of July 20, 2021, "only seven restatements from six companies reference the pandemic as a contributing factor in the misstatement." The report also cautions that "additional scrutiny applied to disclosures and financial statements could result in future litigation or regulatory enforcement."
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