Private Company Financial Reporting Matters

Very few people could have anticipated that COVID-19, which we heard about in late December and early January, would impact our lives and economy to the degree that we are currently experiencing. With significant economic uncertainty arising as private companies are in the midst of their ongoing financial reporting process, many questions and considerations are at the forefront of COVID-19's impact on a company's financial statements and related footnote disclosures, not only for those companies who have yet to issue their fiscal year-end 2019 financial statements, but going forward into 2020.

Recently, DHG hosted a webcast discussing various Private Company Financial Reporting Matters, and a high- level summary our top main points of discussion are below. We encourage you to view the full archived webcast here.

Accounting Estimates

Generally Accepted Accounting Principles (GAAP) requires disclosure of accounting estimates and whether it is reasonably possible that those estimates will change materially in the near term. In our current environment, it is possible to see many estimates subject to significant, material changes in the near term resulting from the pandemic. Companies should pay close attention to their accounting estimates and how they are impacted by COVID-19.

Impairment Analysis

Asset impairment models often take future cash flows into account, and currently many companies are experiencing declining cash flow. Companies may find it difficult to estimate the level of uncertainty and potential duration of the declining cash flow when performing an impairment analysis in the current environment. In particular, indefinite- lived intangible assets, long-lived assets and goodwill are examples that may require a significant amount of estimation in today's uncertain environment.

Other Assets to Consider

Additional asset groups that are subject to possible accounting implications as a result of COVID-19 include inventory, receivables and equity method investments.

Inventory: Accounting Standards Codification (ASC) 330 states that inventory is to be carried at the lower of cost or net realizable value. In the current economic conditions, if prices have dropped, companies should give additional consideration to issues that result from those declining prices. Furthermore, the pandemic may cause an excess production capacity, and GAAP states that companies cannot capitalize inefficiency; those excess costs are rather to be expensed as incurred. For example, in a normal environment, fixed production overhead costs are allocated based on the expected normal production capacity. If the number of units manufactured drops below the expected normal range, and the company continues to incur the same amount of fixed production overhead, the amount per unit would increase, causing an excess of costs (i.e., the inefficiency), which would need to be expensed rather than capitalized.

Accounts Receivable: Companies should evaluate the collectability of their accounts receivable under the current economic conditions and determine whether additional reserves for bad debts are necessary. Also note that proper accounting for accounts receivable will vary if accounted for under ASC 310 or if a company has adopted ASC 326. (For more information, visit DHG's CECL web page.)

Equity Method Investments: With many private companies, it has been uncommon to see impairment on equity method investments. However, given the current circumstances, companies should be aware of various indicators that may lead to impairment. Such indicators of impairment in an equity method investment include an inability to recover the full value of the investment, inability to sustain its earnings, the current fair value being less than the carrying value, or other investors are not providing financial support. Timely recognition of these indicators is imperative for an accurate financial reporting outcome.

ASC 606 Implications

ASC 606 was implemented effective Dec. 31, 2019, for calendar year-end private companies. As is now all too familiar, the new standard for recognizing revenue requires significant judgement and management estimates as part of the five-step framework under ASC 606. One such area requiring significant judgement on the part of management is variable consideration. COVID-19 may greatly impact variable consideration in numerous ways because the probability of certain events may now be different than when originally determined. Examples of the impact may include, but are not limited to, bonuses for timely project completion or changing customer behavior patterns that may impact volume rebates. As such, companies should consider whether estimates may have changed.

Evaluation of Going Concern

When certain conditions are present, and substantial doubt about a company's ability to continue as a going concern arises, a company's management is required to conduct a going concern analysis. One of the initial steps in evaluating going concern is determining if a company will be able to meet its obligations as they come due within 12 months from the date a company's financial statements are issued or available to be issued. In performing their going concern assessment, management may consider the following questions:

• What has happened/is expected to happen to our operations and cash flow as a result of the pandemic?
• What are our plans for the short, moderate and long-term impacts to the business? Have our cash projections been remodeled?
• Has there been a supply chain disruption, such as unanticipated incurred costs or equipment repositioning costs?
• Have the shelter-in-place orders affected revenue and cash flow or are customers and/or their behavior affected by the pandemic?
• Are we planning to defer payment of debts, leases or other obligations?

In assessing management's plan, management should determine whether that plan is probable of alleviating the substantial doubt. Appropriate disclosures of the matter are required in a manner enabling users of the financial statements to understand the events and conditions creating the uncertainty, management's evaluation and related plan to mitigate those concerns or events.

We encourage you to remember to view the full webcast here. For further questions or more information, contact your DHG Advisor or assurance@dhg.com.