All posts by George Wilson

First Quarter COVID-19 Disclosure Examples – Part One

Now that first quarter 2020 Form 10-Q’s have been filed, companies have made COVID-19 disclosures addressing issues ranging from asset impairments to the CARES Act.  In this series of blog posts we hope to help you as you deal with the evolution of these disclosures by reviewing how some companies approached these challenging issues.

This first example is from Starbuck’s Form 10-Q for the quarter ended March 29, 2020.  It is very lengthy.  The company grouped all its COVID-19 disclosures in this single financial statement footnote.  It includes:

 An overview of the situation

A summary of the impact on operations

Long-lived asset impairment discussion

Goodwill impairment considerations

Other asset impairment issues

Rent concession discussion

Deferred tax asset recoverability analysis

CARES Act overview

Discussion and emphasis of uncertainties in future periods

 You will also see that it includes disclosure that sounds like MD&A.  It is interesting that this risk-based disclosure is in the financial statements and that all Starbuck’s COVID-19 impacts were included in this single note rather than being addressed in individual notes for each accounting area.

Note 1

_________

COVID-19

In December 2019, a novel strain of coronavirus (“COVID-19“) was first identified, and in March 2020, the World Health Organization categorized COVID-19 as a pandemic. To help control the spread of the virus and protect the health and safety of our partners (employees) and customers, we began temporarily closing or modifying operating models and hours of our retail stores in many markets both in response to governmental requirements and voluntarily, beyond the requirements of local authorities, during the second quarter of fiscal 2020.

Changes made in our operations, combined with reduced customer traffic, resulted in material reductions in revenues and operating income during the second quarter of fiscal 2020, which prompted us to update our impairment analyses of our company-operated retail store portfolios and related lease right-of-use assets. For certain lower-performing stores, we compared the carrying value of store assets to undiscounted cash flows with updated assumptions on near-term profitability. As a result, we recorded an immaterial asset impairment charge within store operating expenses on our consolidated statement of earnings during the quarter ended March 29, 2020.

We also evaluated our goodwill and indefinite-lived intangible assets at the end of the fiscal second quarter. Our most recently completed goodwill impairment analyses indicated significant excess fair values over carrying values across the different reporting units. Since we expect the negative financial impacts from the outbreak to be temporary, they do not significantly affect the assumptions underpinning our long-term revenue and cash flow growth rates, operating models and business strategies. Therefore, we do not consider the outbreak to be a triggering event to accelerate our annual goodwill impairment analysis. As a result, no impairment charges for goodwill and indefinite-lived intangible assets were recorded during the quarter.

We evaluated our remaining assets, particularly accounts receivable and inventory. Our accounts receivable are mainly comprised of net unpaid invoices for product sales to and royalties from our licensees. Our allowance for doubtful accounts is calculated based on historical experience, licensee credit risk and application of the specific identification method. We also assessed incremental risks due to COVID-19 on our licensees’ financial viability. To assist our international licensed partners during the outbreak, we provided a short-term payment extension for their outstanding receivables as of the end of the fiscal second quarter. We do not believe the form and length of the extension changed our revenue recognition policy or had a significant impact to future collectability. Based on these actions during the quarter ended March 29, 2020, we did not observe a significant deterioration of our receivable portfolio to warrant a significant increase in bad debt expense. We will continue to monitor our accounts receivable as we also committed to providing other forms of relief to certain licensees during the third quarter of fiscal 2020, which may reduce our revenues.

Our inventories are stated at the lower of cost (primarily moving average cost) or net realizable value. We record reserves for obsolete and slow-moving inventory and for estimated shrinkage between physical inventory counts. During the fiscal quarter ended March 29, 2020, we recorded significant inventory write-offs due to expired or the expected expiration of perishable ingredients and products as a result of excess inventory due to the temporary closure of our retail stores. See Note 5, Inventories, for additional details. Depending on the pace of reopening of company-operated stores as well as future customer behaviors, among other factors, we may incur additional inventory write-offs during the third quarter of fiscal 2020.

During the second quarter of fiscal 2020, we received an immaterial amount of COVID-19-related rent concessions for certain stores in China, generally correlating with the limited time period our stores were closed during stay-at-home mandates. Consistent with updated guidance from the Financial Accounting Standards Board (“FASB”) in April 2020, we have elected to treat COVID-19-related rent concessions as variable rent. While we are having ongoing conversations with landlords in various markets in seeking commercially reasonable lease concessions given the current environment, we have not yet confirmed significant concessions for the remainder of the year.

On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which among other things, provides employer payroll tax credits for wages paid to employees who are unable to work during the COVID-19 outbreak and options to defer payroll tax payments. Based on our preliminary evaluation of the CARES Act, we qualify for certain employer payroll tax credits as well as the deferral of payroll and other tax payments in the future, which will be treated as government subsidies to offset relating operating expenses. During the quarter ended March 29, 2020, the qualified payroll tax credits reduced our store operating expenses by approximately $35 million on our consolidated statement of earnings. We expect to record additional payroll tax credits from the U.S. and other governments primarily in our fiscal third quarter to offset qualified wages paid to our partners. We intend to defer qualified payroll and other tax payments as permitted by the CARES Act.

We recorded our income tax expense, deferred tax assets and related liabilities based on management’s best estimates. Additionally, we assessed the likelihood of realizing the benefits of our deferred tax assets. As of the end of the fiscal quarter, we did not record significant valuation allowance adjustments based on available evidence. However, we will continue to monitor the realizability of our deferred tax assets, particularly in certain foreign jurisdictions where the outbreak has started to create significant net operating losses. Our ability to recover these deferred tax assets depends on several factors, including our results of operations and our ability to project future taxable income in those jurisdictions. If we determine that some portion of the tax benefit will not be realized, we would record a valuation allowance, which would increase our income tax expense. Total deferred tax assets as of the end of the fiscal second quarter were approximately $1.7 billion, of which approximately $100 million related to foreign jurisdictions where we expect to incur significant net operating losses in the near term, although the risks of failing to realize these benefits vary across the jurisdictions.

The COVID-19 pandemic remains a rapidly evolving situation. The continuation of the outbreak may cause prolonged periods of store closures and modified operating schedules and may result in changes in customer behaviors, including a potential reduction in consumer discretionary spending in our company-operated and licensed stores. These may lead to increased asset recovery and valuation risks, such as impairment of our company-operated store and other assets and an inability to realize deferred tax assets due to sustaining losses in certain jurisdictions. The uncertainties in the global economy will likely impact the financial viability of our suppliers, licensees and other business partners, which may interrupt our supply chain, limit our ability to collect receivables and require other changes to our operations. These and other factors will adversely impact our net revenues, operating income and earnings per share financial measures.

It should be noted that in this footnote, the discussion of impairment of assets including inventories and receivables comes after the discussion of goodwill impairment.  As a quick reminder, US GAAP requires that all impairment considerations such as inventories, accounts receivable and long-lived assets be taken into account before testing goodwill for impairment.

As always, your thoughts and comments are welcome!

May 4, 2020 SEC Investor Advisory Committee Meeting to Focus on COVID-19 Matters

On April 27, 2020 the SEC announced that its Investor Advisory Committee will hold a virtual meeting on May 4, 2020.  Discussions will focus on two major agenda items:

Public company disclosure considerations in a COVID-19 pandemic context, and

Public company shareholder engagement/virtual shareholder meetings in a COVID-19 pandemic context

You can read the full agenda here.

The meeting will be available via webcast and will also be archived for later viewing.

As always, your thoughts and comments are welcome!

SEC and PCAOB Issue Statement About Emerging Market Investments

On April 21, 2020, SEC Chairman Jay Clayton, PCAOB Chairman William D. Duhnke III, SEC Chief Accountant Sagar Teotia, SEC Division of Corporation Finance Director William Hinman and SEC Division of Investment Management Director Dalia Blass issued a Public Statement titled “Emerging Market Investments Entail Significant Disclosure, Financial Reporting and Other Risks; Remedies are Limited.”

The Statement begins with the observation that over the last several decades U.S. investors have increased their investments in companies based in or with operations in emerging markets.

For companies with emerging markets risks the Statement makes clear that robust disclosure of the specific risks for individual companies is necessary and boilerplate is not adequate:

“In light of both the significance and company-specific nature of the risks discussed in this statement, we expect issuers to present these risks prominently, in plain English and discuss them with specificity.  Issuers based in emerging markets should consider providing a U.S. domestic investor-oriented comparative discussion of matters such as (1) how the company has met the applicable financial reporting and disclosure obligations, including those related to DCP and ICFR and (2) regulatory enforcement and investor-oriented remedies, including as a practical matter, in the event of a material disclosure violation or fraud or other financial misconduct more generally.”

For investors the Statement addresses the very different risks presented by these investments, focusing on issues including:

  • Emerging Market Risk Disclosures are Important
  • Quality of Financial Information, Requirements and Standards Vary Greatly
  • The PCAOB’s Inability to Inspect Audit Work Papers in China Continues
  • The Ability of U.S. Authorities to Bring Actions in Emerging Markets May Be Limited
  • Shareholders Have Limited Rights and Few Practical Remedies in Emerging Markets
  • Passive Investing Strategies Do Not Take Account of These Risks
  • Investment Advisers, Broker-Dealers and Other Market Participants Should Consider Emerging Market Risks

As always, your thoughts and comments are welcome.

The SEC Professionals Group and Examples of COVID-19’s Disclosure Impact

If you are not familiar with the SEC Professionals Group, you will find that this member-managed group is a great source of SEC reporting information, community and support.  One such example is its weekly “Corona Conversations,” which takes place each Friday at 1 p.m. EDT (30 to 60 minutes), where members connect and discuss new topics weekly.  In these virtual meetings, members can raise questions and share insights and knowledge to help support each other as we all deal with the impact of COVID-19.

In the April 17, 2020, “Corona Conversation,” Alyson Clabaugh of Intelligize and George Wilson of SEC Institute reviewed accounting and disclosure areas affected by COVID-19, focusing on questions from members and providing example disclosures from recent filings.  They will continue this review of examples in the April 24, 2020 meeting.

Here are some of the topics included in the April 17 discussions:

  • A disclosure in response to a question about CARES Act disclosures:

AEHR TEST SYSTEMS • 10-Q (Q3 2020) • 04/14/2020
On March 27, 2020, the “Coronavirus Aid, Relief and Economic Security (CARES) Act” was signed into law. The Act includes provisions relating to refundable payroll tax credits, deferment of the employer portion of certain payroll taxes, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The Company is currently analyzing the impact of these changes and therefore an estimate of the impact to income taxes is not yet available. https://apps.intelligize.com/SECFilings/View/Filings/18437872

  • Two examples in response to a question about the classification of lease termination costs:

FRANKLIN COVEY CO • 10-Q (Q2 2020) • 04/09/2020
SG&A Expense. Decreased Direct Office SG&A expense was primarily due to the office closure in China related to the COVID-19 outbreak, reduced travel and advertising costs, and savings in other areas of Direct Office operations. These reductions were partially offset by increased associate expenses resulting from increased commissions on higher sales and new sales and sales-related https://apps.intelligize.com/SECFilings/View/Filings/18431937

OFFICE DEPOT INC• 10-K (FY 2019) • 02/26/2020.
[Risk factor] As a consequence, trade restrictions, including new or increased tariffs, quotas, embargoes, sanctions, safeguards, customs restrictions, epidemics/pandemics, like coronavirus, and mandatory government closures could increase our cost of goods sold or reduce the supply of the products available to us. https://apps.intelligize.com/SECFilings/View/Filings/18325765

  • A reference to CorpFin Disclosure Guidance Topic 9 in response to a question about non-GAAP measures related to COVID-19:

See the non-GAAP guidance here: https://www.sec.gov/corpfin/coronavirus-covid-19

  • An example in response to a question about non-GAAP measure disclosures:

CITIZENS FINANCIAL GROUP INC/RI • 8-K (Items: 2.02, 7.01, 9.01) ● 04/17/2020 • EX-99.1.
Key performance metrics, non-GAAP financial measures and reconciliations – Underlying excluding the impact of COVID-19 on provision for credit losseshttps://apps.intelligize.com/SECFilings/View/Filings/18443473/Exhibits/12110912

  • An example about COVID-19 risks and uncertainties disclosures:

WOD RETAIL SOLUTIONS, INC. • 10-K (FY 2019) • 04/16/2020
Risks and Uncertainties. In December 2019, a novel strain of coronavirus surfaced in China, which has and is continuing to spread throughout the world, including the United States. On January 30, 2020, the World Health Organization declared the outbreak of the coronavirus disease (COVID-19) a “Public Health Emergency of International Concern,” and on March 11, 2020, the World Health Organization characterized the outbreak as a “pandemic”. The governors of New York, California and several other…https://apps.intelligize.com/SECFilings/View/Filings/18442914

  • Three examples in response to a question about the impact of COVID-19 on ICFR:

INTEGRITY APPLICATIONS, INC. • 10-K (FY 2019) • 04/14/2020
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. As the Company has historically had personnel both in the U.S. and Israel, there has been no change in working status due to working remotely as a result of COVID-19.https://apps.intelligize.com/SECFilings/View/Filings/18438236

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/ • 10-Q (Q3 2020) • 04/10/2020
There were no changes in our internal control over financial reporting that occurred during the three months ended February 29, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Subsequent to February 29, 2020, we have not experienced any material impact to our internal controls over financial reporting given that most of our employees are working remotely due to the COVID-19 pandemic. We are continually monitoring and assessing the COVID-19 situation on our internal controls to minimize the impact to their design and operating effectiveness.https://apps.intelligize.com/SECFilings/View/Filings/18434581

INSPIRED ENTERTAINMENT, INC. • 10-K (FY 2019) • 03/30/2020
Our Board of Directors and management take internal control over financial reporting and the integrity of our financial statements seriously. Prospectively and in particular while the current remote working conditions associated with the COVID-19 outbreak remain in effect, Management intends to ensure that all reviews are fully completed prior to issuing the draft financial statements to our external auditors (or where possible make it clear this is the case) . Management will also add an additional third-party external review of the financial statements to the process prior to submission moving forward. At this time, we cannot provide assurance that these remediation efforts will be successful or that our internal control over financial reporting will be effective as a result of these efforts. In addition, we continue to evaluate and work to improve our internal control over financial reporting related to the identified deficiencies that led, in aggregate, to a material weakness, management may determine to take additional measures to address control deficiencies or determine to modify the remediation plan described above. assurance level as of December 31, 2019.https://apps.intelligize.com/SECFilings/View/Filings/18409342

  • Two examples in response to questions about the impact of COVID-19 on CECL:

PNC FINANCIAL SERVICES GROUP, INC. • 8-K (Items: 2.02, 9.01) • 04/15/2020.
Provision for credit losses of $914 million, which was calculated under the Current Expected Credit Loss (CECL) accounting standard effective January 1, 2020, increased $693 million primarily due to the significant economic impact of COVID-19 and loan growth…
https://apps.intelligize.com/SECFilings/View/Filings/18438858

HOME BANCSHARES INC • 8-K (Items: 2.02, 7.01, 9.01) ● 04/16/2020 • EX-99.1
The CECL double accounting for LH-Finance was $9.3 million. The normal CECL loan provision was approximately $5.0 million and the CECL COVID-19 loan provision was approximately $71.7 million. Our CECL provisioning model is significantly tied to projected unemployment rates. As a result of COVID-19, the unemployment rate projections significantly increased from January 1 to the end of March 2020.
https://apps.intelligize.com/SECFilings/View/Filings/18441297

  • A publication about accounting for government assistance in response to a participant question:

EY Guidance on government assistance: TTP08738-201US_CARESAct_04-03-2020.pdf

You can find other disclosure examples in the archived minutes from the April 17 Corona Conversation on the SEC Pro’s group webpage.

The SEC Pro Group also conducts quarterly meetings and other functions to provide support and knowledge for members.  You can learn more and apply for membership here.

You can also complete SEC Pro Group’s benchmarking survey and participate in setting the focus areas for the coming year.

As always, your thoughts and comments are welcome!

SECI’s 35th Midyear Forums to be Offered as Live Webcasts

This June, SEC Institute’s 35th Midyear SEC Reporting and FASB Forums will be offered as live webcasts only rather than being held in person in New York and San Francisco.  This will enable us to provide a safe learning environment for participants and faculty.

The live webcast of the New York program will be on June 11-12, 2020 and will begin at 8:00 a.m. EDT.  The live webcast of the San Francisco program will be on June 15-16, 2020 and will begin at 8:00 a.m. PDT.

Participants will  have access to all program materials, will be able to view the program slides and submit questions to the speakers during the presentation.

As always, the programs will be focused on the key issues facing us in the SEC reporting realm and will include:

  • A review of accounting, disclosure and reporting relief related to COVID-19
  • Focus on accounting and reporting on impairment issues
  • SEC staff focus areas, including, revenue recognition, fair value measurements, segment reporting and non-GAAP measures and metrics
  • Modernization of Regulation S-K and proposed changes to Regulation S-X
  • Business combinations accounting issues, including business combination versus asset acquisition, assigning amounts to assets and liabilities, and contingent consideration
  • Update on MD&A, including disclosures related to the impact of COVID-19, changes from the SEC’s Disclosure Effectiveness project and disclosures concerning reference rate reform and Brexit
  • Status of the credit losses standard implementation and other financial instruments hot topics

You can learn more and register for the webcasts here.

As always, your thoughts and comments are welcome.

FASB Addresses Impact of COVID-19 and Publishes Lease Accounting Q&A

As we mentioned in this post, the FASB met on April 8, 2020, to address “Accounting Relief During the COVID-19 Pandemic.”  You can read Chairman Russell G. Golden’s statement about the meeting here.

Topics addressed were primarily for private companies and not-for-profits.  Steps included decisions to issues proposals for an optional one-year delay for the new leasing standard for private companies and not-for-profits and a one-year delay for the revenue recognition for private company franchisors.

The FASB is also working on a number of question and answer documents related to the disruption created by COVID-19.  On April 10, 2020, the FASB published a Q&A document addressing questions dealing with lease concessions due to COVID-19.  Essentially the Q&A document provides that for such concessions companies will not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract and “can elect to apply or not apply the lease modification guidance in Topic 842 Leases or Topic 840 Leases to those contracts.”

While the meeting minutes are not yet posted, they will be available here when they are completed.  You can read a summary of the tentative decisions reached at the meeting here.

As always, your thoughts and comments are welcome!

A Few Example Proxies for Virtual Annual Meetings

As we discussed in our One-Hour Briefing “COVID-19 Challenges for First Quarter 2020 Form 10-Q and Annual Meetings,” holding a virtual annual meeting involves both state and securities law considerations.  If you are looking for example proxy statements for virtual annual meetings these two from Baxter International and Hub Group may be helpful.

Also, as an FYI, we are hearing about scheduling challenges as companies such as Computershare and Broadridge run out of capacity to accommodate the number of companies moving to virtual formats for their annual meetings.

As always, your thoughts and comments are welcome.

 

An Example of COVID-19 Forewarning Disclosures

In our recent One-Hour Briefing “COVID-19 Challenges for First Quarter 2020 Form 10-Q and Annual Meetings” we reviewed the SEC’s forewarning disclosure requirements.  Thanks to one of the folks listening to the briefing here is an example from BP.  While this is in a press release, it is an early warning and is a reasonable example of the language that would be appropriate in MD&A.  Towards the bottom of the press release in a section titled “First quarter update,” BP makes this statement:

“BP continues to review potential first quarter impairment charges and currently expects to take a non-cash, non-operating charge of around $1 billion in the quarter”

Thanks to all of you who have listened to our COVID-19 related programs, all of which are available without charge, and as always, your thoughts and comments are welcome.

SEC Chair and Corp Fin Director Issue Statement About COVID-19 Disclosure

On April 8, 2020, SEC Chairman Jay Clayton and CorpFin Director William Hinman issued a Public Statement titled “The Importance of Disclosure – For Investors, Markets and Our Fight Against COVID-19.”

The Statement provides valuable thoughts, advice and guidance as we approach quarter-end earnings releases and reporting.  In previous statements and guidance about the impact of COVID-19 the SEC has consistently made the point that in a period of such dramatic disruption and uncertainty, providing investors information about management’s actions and plans to address this disruption is important, despite the uncertainty involved.

This Statement builds on this theme.  Chairman Clayton and Director Hinman say:

“We urge companies to provide as much information as is practicable regarding their current financial and operating status, as well as their future operational and financial planning.”

The Statement includes an extensive series of observations about the current environment and its uncertainties.  It then makes a number of disclosure related requests, including:

“Company disclosures should reflect this state of affairs and outlook and, in particular, respond to investor interest in:

(1) where the company stands today, operationally and financially,

(2) how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing, and

(3) how its operations and financial condition may change as all our efforts to fight COVID-19 progress.  Historical information may be relatively less significant.”

The Statement also enumerates important disclosure considerations in the current environment, including forward looking information issues.  The topics addressed are:

  • Our Collective, Full Mitigation Response to COVID-19 Has Substantially Affected our Economy and Our Markets.
  • SEC Actions Have Focused on Market Integrity and Function
  • There is Broad Support Among Market Participants for COVID-19 Mitigation Efforts
  • There is Broad Recognition of the Need for a Transition to Forward-Looking, Health and Welfare Strategies
  • Frameworks for Forward-Looking Health and Welfare Strategies are Coming Into Focus
  • Extensive Coordination Across the Public and Private Sectors Will Be Essential to Our Success in Fighting COVID-19
  • Q1 Earnings Reports and Related Investor and Analyst Calls Will Not be Routine
  • There is Intense Investor Interest in Company-Specific Operational and Financial Status and Plans for Addressing the Effects of COVID-19
  • We Request that Companies Provide as Much Information as is Practicable Regarding Their Current Status and Plans for Addressing the Effects of COVID-19
  • We Recognize that Producing Forward-Looking Disclosure Can be Challenging and Believe that Taking On that Challenge is Appropriate
  • Robust, Forward-Looking Disclosures Will Benefit Investors, Companies and, More Generally, Our Fight against COVID-19.  Such Disclosures Will Facilitate Communication and Coordination Among the Public and Private Sectors

As we approach quarter-end, this Statement is important reading.

As always, your thoughts and comments are welcome!

SEC Updates Staff Guidance for Conducting Shareholder Meetings in Light of COVID-19 Concerns

On April 7, 2020 the SEC staff updated their guidance about annual meeting processes during the period of disruption cause by COVID-19.  The principle changes are:

The addition of a new section about delays in printing and mailing of full set of proxy materials

An update to clarify that the section on changes in date, time, and location applies to special meetings

An update by the Division of Investment Management to the section on changes in date, time, and location of a shareholder meeting addressing meetings held by investment companies in connection with business combinations or certain other transactions

If you would like more background about this guidance you can listen to the archived version of this complimentary One-Hour Briefing “COVID-19 Challenges for First Quarter 2020 Form 10-Q and Annual Meetings” and this blog post from March 13, 2020 about the original staff guidance.

As always, your thoughts and comments are welcome!