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SEC Chief Accountant Sagar Teotia today issued a Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19, which stressed the importance of continuing to provide high-quality financial information for investors and other stakeholders in these uncertain times. In his statement, among other topics, Teotia addressed estimates and judgments as well as temporary relief provided under the CARES Act that allows banks and other financial institutions to suspend compliance with two provisions of GAAP, including CECL. Teotia emphasized that the Office of Chief Accountant is available for consultation and encouraged companies and others with questions as a result of COVID-19 to contact OCA.

One topic of note was the challenge of making significant judgments and estimates in light of the acute uncertainty resulting from COVID-19.  Consistent with OCA’s historic positions, Teotia confirmed that OCA has “not objected to well-reasoned judgments that entities have made, and we will continue to apply this perspective.” Teotia identified the many accounting areas that may involve significant judgments and estimates in light of the evolving status of COVID-19, and stressed the importance of providing the required disclosures for estimates and judgments:

  • Fair value and impairment considerations;
  • Leases;
  • Debt modifications or restructurings;
  • Hedging;
  • Revenue recognition;
  • Income taxes;
  • Going concern;
  • Subsequent events; and
  • Adoption of new accounting standards (e.g., the new credit losses standard).

Teotia also noted that the CARES Act allows certain entities to temporarily defer or suspend the application of two provisions of GAAP.  First, the CARES Act provides temporary relief for insured depository institutions, bank holding companies and their affiliates from compliance with the new FASB standard for Measurement of Credit Losses on Financial Instruments, including the current expected credit losses methodology for estimating allowances for credit losses, known as CECL.  In addition, the CARES Act provides that a financial institution may temporarily elect to suspend troubled debt restructuring accounting under GAAP.  Teotia confirmed that, if these entities conclude that deferring or suspending these provisions as permitted under the CARES Act is “deemed to be in accordance with GAAP,”  then the “staff would not object to the conclusion.” Accounting speak at its best! 

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Interestingly,  CECL for loan losses also went into effect for large U.S. public companies in December, requiring companies to forecast expected future losses as soon as loans are issued, using economic indicators for forecasting. The CARES Act temporary relief applies only to insured depository institutions, bank holding companies and their affiliates. Although banks will experience the “biggest impact,” according to Bloomberg, the CECL “accounting change applies to all businesses that extend credit to customers.”

As reported by Bloomberg, CECL was adopted as FASB’s

“chief response to the 2008 financial crisis….FASB’s sweeping credit losses accounting overhaul has judgment baked into the rules. It requires banks and other businesses to look to the foreseeable future, consider what happened in the past, and evaluate current conditions to come up with a credit losses estimate that, in theory, better reflects economic reality. It eliminates much-criticized accounting rules that essentially only let banks look in the rearview mirror when tallying their losses. Those rules came under fire in the lead up to the crisis, when bank balance sheets appeared healthy even though most saw deep losses on the horizon.”

A key aspect of CECL, according to Bloomberg, is the requirement that businesses “make a ‘reasonable and supportable’ assessment about the future when they tally expected losses. The uncertainty about the coronavirus could throw what they previously thought of as reasonable out of whack.” As noted in this PubCo post, at yesterday’s meeting of the SEC’s Investor Advisory Committee, a Committee member commented that, in light of the economic conditions resulting from COVID-19, determining impairment of accounts receivable under these conditions could be a “total guess.”

According to the WSJ,  COVID-19 has made it difficult for companies

“to make predictions about credit risk….Finance executives continue to evaluate how the epidemic affects their companies’ ability to collect receivables. If a company raises its forecast for credit losses, its reserves set aside to cover estimated losses could go up, resulting in lower profitability, all other things being equal, accounting experts said. Before CECL, companies didn’t have to recognize losses until they had evidence the losses had been incurred. The incurred-loss model, by definition, had no future component.”

But FASB changed the rule “to provide investors with more transparency about the loan-issuing process and to more closely align companies’ accounting with true risk.”

For guidance on other legal, regulatory and commercial implications of the COVID-19 pandemic, see our Cooley coronavirus resource hub.

Posted by Cydney Posner

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