In March 2020, COVID-19 was officially declared a global pandemic with many countries implementing restrictions on travel, quarantines, and forcing closures of certain businesses. At the time, no one knew how long the pandemic would last or whether the economic impacts would be short or long-term. Months later, this uncertainty continues with some countries seeing increased infection numbers , along with continued strain on the financial markets, consumer confidence, labor workforce, and supply chains. The manufacturing and distribution industry has seen an array of impacts where, depending on the sector, some companies have experienced significant growth to their business while others have seen significant decline or permanent closures.
With the pandemic expected to continue into the near future, many private manufacturing and distribution companies could be dealing with various accounting implications to annual financial reporting. A few accounting areas where companies may be impacted are impairment to assets, capitalization of fixed overhead costs – idle capacity vs. increased production, and borrowers accounting for Paycheck Protection Program (PPP) loans. The remainder of this article will focus on each of these three areas.
Asset Impairment Consideration
Due to impacts from the pandemic, companies may have to deal with potential impairment of assets such as goodwill, intangible assets, long-lived assets, inventory, and others, which will require management to make difficult estimates during a time with significant uncertainty.
For example, long-lived assets are tested for recoverability whenever triggering events indicate their carrying amount may not be recoverable. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 360-10-35-21 provides examples of such triggering events. The following are a few of those events that could exist because of the impacts from the pandemic.
- “A significant adverse change in the extent or manner in which the asset or asset group is being used.”
- “A significant adverse change in the business climate that could affect the value of the asset or asset group.”
- “A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the asset or asset group.”
- “A current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.”
As another example, inventory measured using the “first-in, first-out” or “average cost” methods are to be measured at the lower of cost or net realizable value (NRV), and when there is support that the inventory cost exceeds NRV the difference is recognized as a loss in the period of occurrence. The loss can be triggered by obsolescence, changes in price levels, or other causes stemming from the impacts of the pandemic.
Companies should continue to closely monitor the existence of impairment to its assets and perform timely assessments, as the process could be even more challenging due to the uncertain conditions caused by the pandemic.
Allocation of Fixed Overhead Costs
For manufacturing companies, fixed production overhead costs are allocated to the manufacturing of work-in-process and finished goods inventory based on normal capacity of the production facilities. Normal capacity is defined in FASB ASC Topic 330 as “the production expected to be achieved over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance.” Normal capacity is looked at as a range of production levels with some variation in production levels expected from period to period. The range will vary based on different factors including the business and industry.
When production levels significantly increase above (“abnormally high production”) or decrease below (“abnormally low production” or significant idle-time) normal capacity, adjustments must be made to the allocation of the fixed overhead costs. In periods of abnormally high production, the amount of fixed overhead allocated should be decreased to ensure inventory is not measured above cost.
In contrast, when abnormally low production occurs, the allocation of fixed overhead should not be increased, and those costs should be recognized as expenses incurred during the period rather than as part of inventory. Examples of factors provided by ASC Topic 330 that could cause abnormally low production levels include “significantly reduced demand, labor and materials shortages, and unplanned facility or equipment downtime.” Depending on the business, industry, and location of the production facilities, companies could be facing one or more of these factors due to the economic impacts, supply chain issues, or even restrictions imposed by governmental authorities caused by the pandemic.
PPP Loan Forgiveness – Borrower Accounting
In late March 2020, Congress passed the $2.2 trillion Coronavirus Aid, Relief, and Economic Security (CARES ) Act, which included $349 billion for the Paycheck Protection Program (PPP) to be administered by the U.S. Small Business Administration. A second round of $310 billion was later authorized for the PPP. With the creation of the PPP loans and the potential for forgiveness, questions arose as to how a borrower should account for the loan as U.S. GAAP does not specifically address the accounting for PPP loan forgiveness.
Due to the lack of authoritative or interpretive guidance, the AICPA provided its response in June 2020 on how non-governmental entities could account for a forgivable loan received under the program. The response was included in question 18 of the Technical Questions and Answers (TQA) section 3200, Long-Term Debt. For non-governmental entities that are not a not-for-profit entity, it would be appropriate to account for a PPP loan under ASC 470, Debt, or as a government grant by analogy to IAS 20, Accounting for Government Grants and Disclosure of Government Assistance provided certain conditions are met.
If accounted under ASC 470, the liability would be derecognized once a company has been legally forgiven with the borrower recognizing a gain on extinguishment of debt at the legal release date. If accounted for as a government grant by analogy to IAS 20, the borrower would recognize a deferred income liability for the loan received and subsequently recognize a reduction of the liability and an offset to either (a) other income or (b) a reduction of the related qualified expense. Companies will need to adhere to the disclosure requirements of the applicable accounting guidance elected.
The AICPA staff observed in-substance grants could also be analogized to FASB ASC 958-605 accounting for contributions by not-for-profits or FASB ASC 450-30 gain contingency recognition.
For more helpful resources to navigate COVID-19, visit the Elliott Davis COVID-19 Resource Center.
The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change as a result of evolving legislative developments and government guidance.