Unusual and infrequent times: What are the implications of COVID-19 on your financial statements?
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By: Ryan Istre, CPA
Pardon me if I’m taking too much liberty here, but I think I can say for the masses that if we never hear the words “pandemic,” “unprecedented times,” or “new normal” again, it will be too soon. As an accountant, I propose that we switch phrases – let’s call these “unusual and infrequent times.”
As the months of 2020 roll past us, it will soon be time to work with our clients related to the results of operations for fiscal year 2020. Aside from the challenging business environment that the effects of COVID-19 have caused, other unique challenges will arise for financial reporting purposes – how should the various additional expenses and issues related to COVID-19 be reported? Are there alternative presentations to consider? And is this even necessary? If your company is required to issue financial statements to your owners or banks, you may want to consider these matters now.
The accounting literature has a very verbose way of describing what “special” methods of presentation could be available, and the requirements to be able to use an alternative presentation method. Topic 220-20, “Unusual or Infrequently Occurring Items,” defines these terms as follows:
- Unusual nature – The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.
- Infrequency of occurrence – The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.
When I think back over my career in public accounting, there have only been a few situations that I would consider to even remotely fit the definitions described above. Living in Houston, the obvious are floods and hurricanes, but for most Americans, the major occurrence would likely be the destruction caused on Sept. 11, 2001. That was certainly an unusual and infrequent circumstance, however, shortly after this incident, the Financial Accounting Standards Board (FASB) Emerging Issues Task Force issued a news release as follows:
“At last week's meeting the Task Force concluded that, while the events of September 11 were certainly extraordinary, the financial reporting treatment that uses that label would not be an effective way to communicate the financial effects of those events and should not be used in this case.” The article goes on to discuss that “…it would be very difficult to separate direct effects from indirect in a consistent way.”
The concept of being “difficult to separate direct effects from indirect in a consistent way,” triggers a thought that this may be a very similar situation to the effects that COVID-19 has caused with many businesses. To better understand what may meet the definitions above, the FASB gives us a few guiding examples in the accounting literature:
- A large portion of a tobacco manufacturer’s crops are destroyed by a hailstorm. Severe damage from hail storms in the locality where the manufacturer grows tobacco is rare.
- A steel fabricating entity sells the only land it owns. The land was acquired 10 years ago for future expansion, but shortly thereafter, the entity abandoned all plans for expansion and held the land for appreciation.
- An earthquake destroys one of the oil refineries owned by a large multinational oil entity.
In practice, it would seem rare for events that have occurred on a national or global scale to meet the definitions that the FASB has prescribed. This is primarily the reason that the FASB issued Accounting Standards Update 2015-01 in January 2015, which supplied us with the definitions above and eliminated the concept of “Extraordinary Items” in financial statements.
Perhaps looking at situations from a more individual business-focused measure would be appropriate. There may not be a way to determine what the effects of COVID-19 have had on a business in a direct enough way to be able to distinguish between direct and indirect results, which is likely the way that the FASB has intended their guidance to be interpreted. Following the examples as prescribed by the FASB above, each of the direct effects of those situations should be determinable.
Ultimately, Topic 220-20 allows businesses to report those items that meet the definitions above as separate components of income from continuing operations, or to be disclosed in the notes to financial statements – it does not allow businesses to report these items net of tax, nor does it allow for separate Earnings Per Share measures related to these items to be reported on the face of the income statement. Publicly held entities may likely show the distinct effect of these items in their depiction of management’s discussion and analysis. Other matters that may arise because of the effects of COVID-19 could be exit or disposal costs or potentially certain restructuring costs related to debt.
If you have questions about the applicability of these matters to your company, management should contact audit committees and auditors to understand any implications that this may have on the financial reporting requirements of the business.
This article was originally posted on the Houston Business Journal website.