Year-end Reporting Reminders: Accounting Considerations During Periods with Volatile Economic Conditions

In today’s dynamic and uncertain economic landscape, businesses face numerous challenges that impact their financial reporting and accounting practices. Volatile economic conditions can have far-reaching implications for organizations, requiring careful consideration and proactive measures to ensure accurate financial reporting under United States Generally Accepted Accounting Principles (“US GAAP”).

It is crucial for organizations to stay up to date on accounting guidance (including recent pronouncements), assess the impact of economic conditions on their financial statements, and work closely with their accounting advisors to address these considerations effectively. The following is but a sample of “hot button” issues accounting and finance professionals should consider as part of their year-end close and financial reporting processes:

1. Impact of Rising Interest Rates on Lease Accounting under Accounting Standards Codification (“ASC”) 842¸Leases

With rising interest rates, businesses may experience changes in their borrowing costs, impacting the accounting for leases under ASC 842. Specifically, the incremental borrowing rate used to determine the present value of lease payments may be affected. Organizations should reassess their incremental borrowing rate to reflect current market conditions and ensure compliance with the standard. Failure to accurately assess and adjust the borrowing rate can result in misstated lease liabilities and lease assets.

2. Collectability and CECL (ASC 326), Financial Instruments – Credit Losses

During volatile economic conditions, organizations may face challenges with the collectability of receivables, affecting the estimation of expected credit losses under the Current Expected Credit Loss (“CECL”) standard. Entities must consider historical information, current conditions (both internal and external), and reasonable and supportable forecasts when estimating credit losses. Increased credit risk and uncertain economic conditions may require organizations to enhance their credit risk management processes and data collection capabilities to accurately estimate expected credit losses.

3. Accounting for Restructurings, Including One-Time Severance Costs

In uncertain economic times, organizations may need to restructure their operations to align with changing market conditions. Accounting for restructurings involves recognizing and measuring one-time severance costs and other related expenses. Organizations should carefully evaluate the criteria outlined in ASC 420 (Exit or Disposal Cost Obligations) to determine when restructuring costs should be recognized. Organizations must carefully evaluate the specifics of each arrangement (e.g. severance or other one-time employee termination benefits), particularly with respect to the communication date to the employee and whether continued service is required, to ensure the related liability is recognized in the correct period.

Additionally, an organization should consider potential “spill-over” impacts of exit, disposal, or restructuring activities. These transactions can have wide-reaching impacts across multiple financial statement line items and footnote disclosures, including items such as:

• Asset groups – An organization must reassess its asset group(s) based on changes in facts and circumstances, including changes in operating structure and how an organization utilizes its assets. As part of an exit activity, such as a “reduction in force” plan (a “RIF”) or a disposition, an organization may sublease a facility, change how a facility is used, or cease using it all together. These might all indicate that previous asset group conclusions should be re-considered, and may warrant further analysis as potential impairment triggers. Appropriately determining asset groups is a key first step, as the cash flows of a “winning” asset group cannot be used to mask the underperformance of another.
• Stock-based compensation matters – As part of a RIF, an organization may provide for accelerated vesting for the separated employees. Entities should carefully evaluate whether stock-based awards are modified, settled, or exchanged, as each has differing accounting and reporting implications. If the separated employees are executives or highly compensated individuals, the organization could end up having to reverse compensation expense related to unvested awards, impacting the comparability of stock-based compensation expenses with prior periods.
• Segment reporting – In contemplating the disposition of a subsidiary or business unit, an organization may update its monthly reporting package to provide “with and without” views. In such circumstances, an organization should re-evaluate previous conclusions regarding operating and reportable segments.

4. Potential Triggering Events and Impairment Considerations under ASC 350 and ASC 360

Volatile economic conditions can lead to potential triggering events that require impairment assessments under ASC 350 (Intangibles – Goodwill and Other) and ASC 360 (Property, Plant, and Equipment). Organizations should closely monitor events such as a significant decline in the market value of assets, changes in the competitive landscape, or adverse changes in the regulatory environment. These events may necessitate impairment testing to determine if the carrying value of certain assets exceeds their recoverable amount, leading to potential impairment charges.

With impairment testing, the order of operations is key. Failure to appropriately apply the guidance can lead to potentially incorrect conclusions with respect to both the presence and amount of impairment:

• First, an organization is required to assess indefinite-lived intangible assets using the guidance in ASC 350-30. The guidance requires an annual assessment that becomes more frequent if impairment indicators exist.
  • Also in this first step, an organization will subject other assets, including items such inventories, accounts receivable, contract assets, and equity method investments, to impairment testing using the applicable guidance for each balance or class of transactions.
• Second, the organization should evaluate long-lived assets to be held and used under ASC 360-10. There is no annual requirement to test such assets, and further assessment is only needed if impairment indicators exist.
• Lastly, the organization should test goodwill for impairment under ASC 350-20. Consistent with step #1, the guidance requires an annual assessment that becomes more frequent if impairment indicators exist.

The guidance in both ASC 350 and 360 requires organizations to evaluate the potential for triggering events before such events and circumstances arise. This assessment cannot be deferred to the organization’s fiscal year-end or annual impairment testing date. A subsequent recovery, such as a sustained increase in share price, improving economic conditions, or obtaining a significant new customer, does not eliminate the need to perform further analysis in response to events or circumstances that require impairment testing.

Ask Marcum

At Marcum, we understand the challenges faced by businesses during volatile economic conditions. Our team of experienced professionals can provide guidance and support in navigating these accounting considerations, ensuring compliance with applicable accounting standards and accurate financial reporting. Contact us today to learn more about how we can assist your organization in successfully managing accounting challenges during uncertain economic times.