On June 23, 2020, the Office of the Chief Accountant (OCA) of the Securities and Exchange Commission (SEC) issued another statement on the importance of high-quality financial reporting in light of the impact of, and uncertainties related to, COVID-19. The statement targets stakeholders in the financial reporting system and public companies preparing for the second quarter financial reporting period and follows a similar statement issued by the OCA on April 3, 2020, during the first quarter financial reporting period.
OCA's statement highlights the importance of timely, high-quality, decision-useful information to investors and our public capital markets and emphasizes the critical role that participants in our financial reporting system (e.g., preparers, auditors, audit committee members) play in the functioning of our markets and in the collective national effort to mitigate the COVID-19 pandemic.
The statement discusses some of the significant accounting, auditing and financial reporting topics recently addressed by OCA, including:
- Significant estimates and judgments
- Disclosure controls and procedures (DCP) and internal control over financial reporting (ICFR)
- Ability to continue as a going concern
- Audit committees and auditor independence.
Significant Estimates and Judgments
In connection with their financial reporting responsibilities, OCA points out that many companies have been required to make significant judgments and estimates to address a variety of accounting and financial reporting matters. OCA explains that it typically has not objected to well-reasoned judgments that entities have made, and will continue to apply this perspective. According to OCA, companies should ensure that significant judgments and estimates are disclosed in a manner that is understandable and useful to investors, and that the resulting financial reporting reflects, and is consistent with, the company's specific facts and circumstances.
Disclosure Controls and Procedures and Internal Control Over Financial Reporting
In connection with maintaining DCP and ICFR, management must evaluate the effectiveness of a public company's DCP as of the end of each fiscal quarter, and the effectiveness of its ICFR at the end of each fiscal year. OCA understands that preparers have adapted, or are adapting, their financial reporting processes as they respond to the changing environment. According to OCA, these changes may include consideration on how controls operate or can be tested and if there is any change in the risk of the control operating effectively in a telework environment. In addition, OCA points out that changes to the business and additional uncertainties may result in additional risks of material misstatement to the financial statements in which new or enhanced controls may need to be implemented to mitigate such risks. OCA reminds preparers that if any change materially affects, or is reasonably likely to materially affect, an entity's ICFR, such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred (or fiscal year in the case of a foreign private issuer).
Ability to Continue as a Going Concern
Financial reporting pursuant to U.S. generally accepted accounting principles (GAAP) presumes a reporting entity has the ability to continue as a going concern. OCA reminds preparers that in each reporting period, including interim periods, management should 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, OCA instructs management to consider whether its plans alleviate such substantial doubt, and make appropriate disclosures to inform investors. According to OCA, 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. OCA notes that GAAP requires such disclosure in the notes to the financial statements, and this may be incremental to other SEC filing disclosure requirements.
OCA points out that auditors also have responsibility to evaluate an entity's ability to continue as a going concern based on their knowledge of relevant conditions that exist at, or occurred prior to, the date of the auditor's report. Although a review of interim financial information is not designed to identify conditions or events that indicate substantial doubt about an entity's ability to continue as a going concern, an auditor may become aware of such conditions or events in the course of performing review procedures. In such cases, OCA notes that auditors should inquire with management and consider the adequacy of the relevant disclosures' conformity with GAAP. OCA reminds auditors that after performing such procedures, to the extent the auditor determines the relevant disclosure is inadequate such that it represents a departure from GAAP, the auditor should extend the procedures, evaluate the results and communicate as appropriate with the issuer and its audit committee.
Audit Committees and Auditor Independence
OCA reiterates the key role that audit committees play in the financial reporting system through their oversight of financial reporting, including ICFR and the external, independent audit process. According to OCA, in these times of rapid change and increased uncertainty, the need for the oversight role that audit committees play is as critical as ever. OCA notes that the most effective audit committees are engaged, executing their responsibilities with diligence, and this engagement significantly enhances the financial reporting output. OCA continues to emphasize the important role of the audit committee to participants across the financial reporting system and that OCA will continue to be proactive in engaging with audit committee members to understand current market developments and solicit their perspectives on improving the oversight of financial reporting.
OCA also reminds all stakeholders that auditor independence is foundational to the credibility of financial statements, noting that auditor independence is a shared responsibility among audit committees, management and their auditors. OCA believes that when each of these groups work together, it fosters the most effective environment to achieve compliance with the independence rules.
Contacting OCA
As we enter the second quarter financial reporting season, OCA reminds stakeholders in the financial reporting system that it remains available for consultation and encourages public companies, auditors and others to contact it with questions they encounter as a result of COVID-19 or other emerging issues. Some of the issues OCA addressed during the first quarter financial reporting cycle included the financial reporting ramifications of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), debt modifications, hedging, consolidation, business combinations, lease concessions, revenue recognition and income taxes. OCA points out that it has processes in place to provide staff views on the application of GAAP and International Financial Reporting Standards to complex, unique or novel issues and is committed to supporting preparers, auditors and others in fulfilling their critical financial reporting responsibilities.
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