In our last post we started a series to explore examples of disclosures companies have made to address issues raised by COVID-19 in their first quarter 2020 Form 10-Q’s.

This second example is from Alphabet’s Form 10-Q for the quarter ended March 31, 2020.  Unlike Starbucks, who put all their COVID-19 related financial statement disclosures in one footnote, Alphabet included disclosure as appropriate in relevant footnotes.

First, here is an addition Alphabet made in their 1995 Private Securities Litigation Reform Act safe harbor meaningful cautionary statements:

Note About Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things, statements regarding:

• the effect of the novel coronavirus pandemic (“COVID-19”) on our business, operations, and financial results, including the effect of governmental lockdowns, restrictions and new regulations on our operations and processes;

In the notes to the quarterly financial statements this language was added to the Use of Estimates section:

Use of Estimates

………

As of March 31, 2020, the impact of the outbreak of COVID-19 continues to unfold. As a result, many of our estimates and assumptions required increased judgment and carry a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, our estimates may change materially in future periods.

 In their discussion of the allowance for uncollectible accounts receivable Alphabet added the bolded language below to their disclosure:

Accounts Receivable

Our payment terms for accounts receivable vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customers, we require payment before the products or services are delivered to the customer.

We maintain an allowance for credit losses for expected uncollectible accounts receivable, which is recorded as an offset to accounts receivable and changes in such are classified as general and administrative expense in the Consolidated Statements of Income. We assess collectibility by reviewing accounts receivable on a collective basis where similar characteristics exist and on an individual basis when we identify specific customers with known disputes or collectibility issues. In determining the amount of the allowance for credit losses, we consider historical collectibility based on past due status and make judgments about the creditworthiness of customers based on ongoing credit evaluations. We also consider customer-specific information, current market conditions and reasonable and supportable forecasts of future economic conditions to inform adjustments to historical loss data.

For the three months ended March 31, 2020, our assessment considered business and market disruptions caused by COVID-19 and estimates of expected emerging credit and collectibility trends. The continued volatility in market conditions and evolving shifts in credit trends are difficult to predict causing variability and volatility that may have a material impact on our allowance for credit losses in future periods. The allowance for credit losses on accounts receivable was $275 million and $717 million as of December 31, 2019 and March 31, 2020, respectively.

In their disclosure about equity investment Alphabet added COVID-19 considerations in the bolded language below:

Equity Investments

The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method.

Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. All gains and losses on marketable equity securities, realized and unrealized, are recognized in other income (expense), net.

Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). We qualitatively assess whether indicators of impairment exist. Factors considered in our assessment include the companies’ financial and liquidity position, access to capital resources, exposure to industries and markets impacted by COVID-19, and the time since the last adjustment to fair value, among others. If the assessment indicates that the investment is impaired, we estimate the fair value by using the best information available, which may include cash flow projections or other available market data. The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the impact.

Alphabet addressed COVID-19’s impact on taxes:

Note 14. Income Taxes

Our effective tax rate for the three months ended March 31, 2020 was lower than the U.S. federal statutory rate, primarily due to the U.S. Research and Development Tax Credit, the Foreign-Derived Intangible Income tax benefit, and stock-based compensation related tax benefits. Our effective tax rate is based on forecasted annual results which may fluctuate significantly through the rest of the year, in particular due to the uncertainty in our annual forecasts resulting from the unpredictable impact of COVID-19 on our operating results.

Lastly, Alphabet added the following to the introduction to their MD&A:

The Impact of COVID-19 on our Results and Operations

In late 2019, an outbreak of COVID-19 emerged and by March 11, 2020 was declared a global pandemic by The World Health Organization. Across the United States and the world, governments and municipalities instituted measures in an effort to control the spread of COVID-19, including quarantines, shelter-in-place orders, school closings, travel restrictions and the closure of non-essential businesses. By the end of March, the macroeconomic impacts became significant, exhibited by, among other things, a rise in unemployment and market volatility.

For most of the quarter ended March 31, 2020, our results reflect historical trends and seasonality. However, in March 2020 we experienced a decline in advertising revenues due to the impact of COVID-19 and the related reductions in global economic activity. While users’ search activity increased, their interests shifted to less commercial topics. In addition, our advertising revenues were negatively affected by reduced spending by our advertisers in response to the macroeconomic impact.

We also assessed the realized and potential credit deterioration of our customers due to changes in the macroeconomic environment, which has been reflected in an increase in our allowance for credit losses for accounts receivable. In addition, we experienced declines in the valuation of our equity investments.

Looking ahead, the full impact of COVID-19 on our business is unknown and highly unpredictable. Our past results may not be indicative of our future performance and historical trends in revenues, operating income, operating margin, net income, EPS, among others, may differ materially. For example, to the extent the pandemic continues to disrupt economic activity globally we, like other businesses, would not be immune as it could adversely affect our business, operations and financial results through prolonged decreases in advertising spend, credit deterioration of our customers, depressed economic activity, or declines in capital markets. In addition, many of our expenses are less variable in nature and may not correlate to changes in revenues. The extent of the impact will depend on a number of factors, including the duration and severity of the pandemic; advances in testing, treatment and prevention; and the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures.

To address the potential impact to our business, over the near-term, we are reevaluating the pace of our investment plans, including, but not limited to, our hiring, investments in data centers, servers, network equipment, real estate and facilities, and marketing and travel spending, as well as taking certain measures to support our customers.

Within MD&A Alphabet also addressed the impact of COVID-19 on various operating units:

Google advertising revenues

In addition to the impact of COVID-19, our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google properties and the change in impressions and cost-per-impression on Google Network Members’ properties and the correlation between these items, have been affected and may continue to be affected by various factors, including:

• advertiser competition for keywords;
• changes in advertising quality, formats, delivery or policy;
• changes in device mix;
• changes in foreign currency exchange rates;
• fees advertisers are willing to pay based on how they manage their advertising costs;
• general economic conditions;
• seasonality; and
• traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels.

As always, your thoughts and comments are welcome!

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!