A couple of days ago, Sagar Teotia, SEC Chief Accountant, issued a Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19. The Statement, issued in advance of the close of the second quarter, follows on Teotia’s earlier Statement, issued in April, in which Teotia addressed, among other topics, estimates and judgments as well as temporary relief provided under the CARES Act for banks and other financial institutions. (See this PubCo post.) In this new Statement, Teotia again addresses estimates and judgments, as well as disclosure controls and procedures and internal control over financial reporting, going-concern issues, engagement by the Office of Chief Accountant with FASB, the PCAOB and international standard setters and OCA’s engagement with audit committees.
Estimates and Judgments
In his prior Statement, Teotia had highlighted the challenge of making significant judgments and estimates in light of the acute uncertainty resulting from COVID-19. In his new Statement, he reiterated that, with respect to estimates and judgments, OCA has “consistently not objected to well-reasoned judgments that entities have made,” and emphasized that OCA “will continue to apply this perspective.” In that regard, companies must provide disclosure about significant judgments and estimates that is “understandable and useful to investors.” In addition, the resulting financial reporting must reflect and be “consistent with the company’s specific facts and circumstances.”
DCP and ICFR
One consequence of COVID-19 has been the pervasive transition to teleworking where possible, which inevitably affects companies’ ability to monitor and test their ICFR. Teotia observes that companies have had to consider how their adaptation to teleworking affects the operation and testing of their controls, including the risk that their controls may not operate as effectively when the workforce is working from home. In addition, Teotia notes 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.
GAAP presumes that a reporting entity will be able to continue as a going concern. Consistent with the contemporaneous advice from the staff of Corp Fin in Disclosure Guidance: Topic No. 9A (see this PubCo post), Teotia reminds us that, each quarter, it is up to management to consider
“whether relevant conditions and events, taken as a whole, raise substantial doubt about the entity’s ability to meet its obligations as they become due within one year after the issuance of the financial statements. In instances where substantial doubt about an entity’s ability to continue as a going concern exists, management should consider whether its plans alleviate such substantial doubt, and make appropriate disclosures to inform investors. Such disclosures should include information about the principal conditions giving rise to the substantial doubt, management’s evaluation of the significance of those conditions relative to the entity’s ability to meet its obligations, and management’s plans that alleviated substantial doubt. If after considering management’s plans substantial doubt about an entity’s ability to continue as a going concern is not alleviated, additional disclosure is required.”
The disclosure is required by GAAP in the notes to the financial statements, in addition to disclosure that may be required elsewhere in periodic filings, such as in MD&A.
In addition, auditors share management’s responsibility to evaluate going-concern issues. Although auditors’ quarterly reviews are not designed for that purpose, an auditor may nevertheless become aware of conditions or events that raise the question and then should “inquire with management and consider the adequacy of the relevant disclosures’ conformity with GAAP.” If the auditor determines that the disclosure is inadequate and does not comply with GAAP, the “auditor should extend the procedures, evaluate the results and communicate as appropriate with the issuer and its audit committee.”
Through their oversight of financial reporting, ICFR and the independent audit process, audit committees play a key role in financial reporting that is as critical as ever. Teotia contends that the SOX reforms regarding audit committees “have proven to be some of the most effective financial reporting enhancements included in the Sarbanes-Oxley Act.” OCA’s engagement with audit committees help OCA understand current market developments and OCA intends to continue to “solicit their perspectives on improving the oversight of financial reporting.”