Top Accounting Impacts on Professional Services Firms in the Wake of COVID-19

calendar iconOctober 1, 2020

By: Chase Wright, Partner, Risk Assurance & Advisory Services and Matt Dobbins, Manager, Risk Assurance & Advisory Services

Many professional services firms have quickly adapted to conducting business during COVID-19.  Under best-case scenarios, firms have championed virtual collaboration and engagement models that are quickly starting to become the way firm’s will continue to do business going forward.

The uncertainties relating to the duration of the COVID-19, the economy, supply chains, and financial markets have created many challenges for professional services firms. Because of this volatility, many firms have been forced to take a closer look at current operations and development plans for both the short- and long-term effects this will have on employees and customers. Further complicating matters are the key accounting considerations that need to be made.

Long-lived Assets and Goodwill Impairments

Firms are required to perform impairment tests annually or when a triggering event has occurred, such as today’s COVID-19 outbreak, which has led to many types of internal and external impairment triggers. A few examples triggers include significant decreases in the market value of assets, decrease in the extent or manner the asset is being used (reduced capacity due to ‘social distancing’), current period operating loss coupled with a history of losses, decrease in customer demand, or decreased selling prices and/or profit margins.

Impairment tests for other intangible assets generally consist of a mix of management provided assumptions but using more complex valuation models that typically involve assistance from third party service providers. Goodwill and indefinite-lived intangible assets follow the impairment model outlined in ASC 350, while assets with determinable useful lives (such as right-of-use assets) follow ASC 360.

Some professional services firms enable their human capital with significant investment in property, plant and equipment. The value of property, plant and equipment are impacted by temporary or permanent closures, reduced operating hours, mandated reduced occupancy capacities, and various other challenges during this time. For some firms, only certain locations are affected while others are broader based, so judgment will be required to identify the assets at risk, and to what extent grouping the assets for a test is appropriate. Impairment testing for these assets is sometimes based on internal projections where underlying assumptions should be consistent with those used in other tests discussed above if applicable, while other assets have the best indication of value by market observations such as appraisals or similar sales.

Lease Considerations

For professional services firms, lease cost and payroll are most likely their largest expenditures. The ongoing pandemic has shifted the view for many on whether office space is required and as a result, forced firms to closely review current leases for office space. Under the historic lease guidance of ASC 840, capital leases are subject to ASC 360 impairment guidance discussed in the long-lived asset section above. Under the new lease guidance of ASC 842, right of use assets also follow the ASC 360 impairment guidance described above.

Some leases contain ‘force majeure’ clauses that call for changes in lease payments. Others have negotiated lease concessions with landlords. These changes may lead to treatment of rent abatements as variable lease payments if the duration of the abatement is uncertain. If lease payments are revised, then firms should follow lease modification accounting guidance.

Financial Asset Valuations

Investments without readily determinable prices may present additional challenges in this environment, with increased judgment necessary to support pricing. Firms with equity method investments (investments in companies that demonstrate significant influence, which is typically 20 to 50 percent ownership) present similar challenges for many industries not just professional services, as the underlying firm may have similar or different challenges than that of the investor. Impairment for an equity method investment is recognized when the decline in value is deemed to be “other than temporary.” Coronavirus could exacerbate judgment required to determine if the decline is other than temporary.  Firms need to consider:

  • Duration and severity of market decline;
  • Financial condition of investee;
  • Prospects of investee; and
  • Intent and ability to retain investment to allow for any recovery.

Collection of trade and note receivables, loans, and other assets held at amortized costs may present additional risk. Although hindsight is the best tool for assessing collections, firms may need to revisit their historic allowance practices. This is especially true given the economic stability prior to this outbreak, as the future outlook of many models may no longer be consistent with what we are seeing in the current environment. Many firms that appeared sound and credit worthy may no longer be due to the virus and all it affected.

Debt Covenant Violations and Waivers

Firms that violate their debt covenants within a reporting period should reclassify any outstanding long-term balance to a current liability. Firms can continue the long-term classification if a debt covenant violation waiver is received and valid for at least one year after the period end, and if the entity can conclude that it is not probable of violating the same or another covenant within one year of the period end balance sheet date.

Firms working with existing lenders to restructure their existing debt should determine if there was a resulting decrease in the effective interest rate, and if so, should follow the accounting for trouble debt restructuring. If the effective interest rate increased, then the entity should consider when the transaction is a restructuring or extinguishment of debt.

Revenue Recognition

Under ASC 606, a sales contract does not exist unless its collectability is probable. Firms may need to evaluate whether its current and new clients have the ability to pay for services to meet the revenue recognition criteria. If not, revenue should not be recognized until all performance obligations have been fulfilled by the entity and the consideration is received, or the agreement is terminated, and any consideration received to date is nonrefundable.

Client facing financial difficulties may seek concessions with pricing or discounts from prior balances. Such concessions should be treated as variable consideration reducing the transaction price in step three of the five-step ASC 606 model.

Growing Concern

ASU 2014-15 requires management to evaluate whether there are conditions that raise substantial doubt about the entity’s ability to continue as a going concern. The COVID-19 pandemic presents numerous potential indicators as discussed above, along with ongoing uncertainty of the general economic outlook coupled with individual firms’ financial position and liquidity. Management’s evaluation should consider all information available through the date the financial statements are to be issued, and not just as of the reporting period end balance sheet date.

The forward-looking period for this purpose is one year after the date the financial statements are to be issued or are ready to be issued. It is important to ensure that cash flow projections, closures, cost cutting measures, asset sales and other data points are consistent with the various analysis covered in the areas discussed above as these types of plans may trigger additional accounting considerations.

If negative conditions are identified, then additional disclosures are required in the footnotes, regardless of whether those conditions are mitigated by management’s analysis.

How Our Professional Services Group Can Help You Navigate Accounting Complexities

Cherry Bekaert can guide your professional services company, helping you navigate complex accounting issues brought on by COVID-19 and adapt to the challenges and opportunities it has created. Please contact Scott Duda or Chase Wright. You can also check out our COVID-19 Guidance Center for more topics that might be of interest to you.