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Oil and gas companies: 2020 Q2 accounting, financial reporting, and regulatory developments

August 6, 2020 / 22 min read

In this update, we highlight some of the more important 2020 second quarter accounting, financial reporting, and regulatory developments that may impact oil and gas companies. The content is not meant to be all-inclusive.

The Financial Accounting Standards Board (FASB) issues several Accounting Standards Updates (ASUs) that impact oil and gas organizations. Key ASUs for all organizations are discussed in depth in the Accounting and Financial Reporting Developments for Public and Private Companies Newsletters.

Accounting guidance issued in response to COVID-19 pandemic

Lease accounting

In response to questions from stakeholders on accounting for lease modifications and concessions during the COVID-19 pandemic, the FASB staff issued FASB Staff Q&A - Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic. The main issues addressed in the Q&A document were:

Hedge accounting

The FASB staff issued FASB Staff Q&A – Topic 815: Cash Flow Hedge Accounting Affected by the Covid-19 Pandemic in response to stakeholder questions on how the postponement or cancellation of forecasted transactions due to COVID-19 should be treated when applying hedge accounting. The FASB staff clarified that when applying cash flow hedge accounting, entities would be able to apply the exception in paragraph ASC 815-30-40-4 for rare cases caused by extenuating circumstances outside the control of the entity. This means that if a forecasted transaction is delayed as a result of COVID-19 an entity would not automatically have to discontinue hedge accounting. Entities would still need to evaluate if the forecasted transactions are probable of occurring within a reasonable time period beyond the normal time period. This ASU benefits companies with shut-in production or other production declines applying cash flow hedge accounting.

The FASB staff also clarified that given the unprecedented nature of the pandemic, missed forecasts or forecasted transactions that result from COVID-19 would not call into question an entity’s ability to accurately predict forecasted transactions in the future. Entities will need to use judgment to determine whether or not COVID-19 is the reason for the missed forecasts or forecasted transactions.

AICPA issues guidance on accounting for Paycheck Protection Program loans

In June 2020, the AICPA issued Technical Q&A Section 3200.18 (“TQA 3200.18”) to provide guidance on accounting for forgivable loans received under the Paycheck Protection Program (PPP) provided for under the CARES Act and administered by the Small Business Administration (SBA). Questions on accounting for PPP loans had arisen as the loans are legally structured as debt instruments; however, many entities and financial statement users believe the loans are in substance a government grant since they are eligible for forgiveness. Given the unique nature of these loans, the AICPA’s TQA 3200.18 specifies that the following accounting models may be appropriate depending on the facts and circumstances.

  1. Debt model: Because the PPP loans are legally structured as debt, entities may always choose to account for them as debt instruments using the guidance in ASC 470. Under the debt model, the PPP loan would be accounted for as a financial liability based on the contractual terms. Entities would not be required to impute interest at market rates based on an exception in ASC 835-30 for loans where interest rates are prescribed by governmental agencies. Under the debt model, the PPP loan would continue to be recorded as a financial liability until it is either repaid, or the loan has been forgiven. If forgiven, the liability would be removed, and the entity would record a gain on debt extinguishment.
  2. Grant revenue guidance in ASC 958: The second option in TQA 3200.18 is to account for PPP loans following the guidance in ASC 958-605. While for-profit business entities are not in the scope of ASC 958-605, TQA 3200.18 states that businesses could apply this guidance by analogy based on the lack of authoritative guidance on accounting for government grants. Entities should only use this guidance if at the time of receiving the PPP loan the conditions for loan forgiveness are expected to be substantially met. Under this model, the PPP loan proceeds would be recorded as a deferred income liability and at the time the grant terms are substantially met, the proceeds would be reported as grant income. If conditions change after receipt of the PPP loan and the entity no longer expects the loan forgiveness terms will be substantially met, the PPP loan should be accounted for as debt.
  3. International Financial Reporting Standards (IFRS) government grant model: Business entities may also elect to account for PPP Loans by analogizing to the guidance in International Accounting Standard 20, Accounting for Government Grants and Disclosure of Government Assistance (“IAS 20”) if certain conditions are met. In order to apply the IAS 20 model, the borrower must be able to support from loan inception until ultimate forgiveness that it is probable the loan forgiveness criteria will be met. The term ‘probable’ is used consistently with other areas of U.S. Generally Accepted Accounting Principals (GAAP) and means an event is likely to occur (a high threshold). As long as it continues to be probable the entity will meet the forgiveness criteria, grant income is recognized on a systematic basis as the qualifying expenses are incurred. If the entity were no longer able to conclude it is probable that the forgiveness criteria will be met, then the entity should discontinue applying the IAS 20 model and account for the PPP loan as debt.

Regulatory update: COVID-19-related

SEC COVID-19 response

The SEC has taken numerous actions to address registrant, investor, and market COVID-19 concerns, which are accumulated and discussed at the SEC COVID-19 Response site. We discuss some of the more important guidance and actions in the second quarter below and encourage companies to monitor the SEC website for current communications.

SEC stresses continued importance of financial reporting in light of COVID-19

On June 23, 2020, SEC Chief Accountant Sagar Teotia published a statement regarding the importance of providing investors with high-quality financial information and summarizing the efforts of the Office of the Chief Accountant (OCA) in this regard. Some of the highlights of the statement follow.

Division of corporation finance issues additional disclosures guidance for COVID-19

On March 25, 2020, the Division of Corporation Finance (Corp Fin) issued CF Disclosures Guidance: Topic No. 9, Coronavirus (COVID-19), to provide its current views regarding disclosure and other securities law obligations that companies should consider with respect to COVID-19 and related business and market disruptions (we discussed in our First Quarter newsletter). On June 23, 2020, Corp Fin provided additional views regarding operations, liquidity, and capital resources disclosures in CF Disclosures Guidance: Topic No. 9A, Coronavirus (COVID-19) — Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources.

Disclosures assessment: Operations, liquidity, and capital resources

Companies have undertaken and are generally in the process of making a diverse range of operational adjustments as well as a diverse and sometimes complex range of financing activities in response to the effects of COVID-19. The operational adjustments may have a material effect on a company that requires an obligation to disclose this information to investors. It is also important that companies provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties. Corp Fin observed companies making some of these disclosures in their earnings releases but encourages companies to evaluate whether any of the information should also be included in management discussion and analysis (MD&A).

The staff guidance provides a list (not all inclusive) of a broad range of questions for companies to consider with respect to their disclosure obligations:

Government assistance: The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)

Companies receiving federal assistance under the CARES Act should consider the short- and long-term impact of that assistance on their financial condition, results of operations, liquidity, and capital resources, as well as the related disclosures and critical accounting estimates and assumptions. The staff guidance provides a list of questions for companies to consider with respect to their disclosure obligations:

Company’s ability to continue as a going concern

Management should consider whether conditions and events, taken as a whole, raise substantial doubt about the company’s ability to meet its obligations as they become due within one year after the issuance of the financial statements. There are required financial statement disclosures when there is substantial doubt about a company’s ability to continue as a going concern or in cases where the substantial doubt is alleviated by management’s plans. Companies should also consider the following questions regarding the MD&A disclosure:

ICFR considerations

Companies may have changes to their processes and internal controls as they adapt to the new conditions necessitated by COVID-19, such as working remote, personnel losses, and other constraints. These changes may require disclosure in the Forms 10-K and 10-Q. Management and audit committees should consider the disclosure requirements related to the establishment of new controls, redesigning of controls and processes.

Center for Audit Quality (CAQ) COVID-19 resources

The CAQ has developed a resource page to help auditors, management, and audit committees understand the impact of the COVID-19 on financial reporting and oversight. We discuss some of the publications in the second quarter below and encourage companies to monitor the CAQ website for current resources.

COVID-19 resource: Key auditor and audit committee considerations

In April 2020, the CAQ issued a publication with key considerations for upcoming filings. We discussed the publication in our First Quarter newsletter. Accounting and financial reporting implications of COVID-19 may require companies to make significant judgments and estimates, which can be challenging in an environment of uncertainty. The publication contains questions on certain accounts and disclosures for management, auditors, and audit committees to consider.

COVID-19 considerations for non-GAAP financial measures and performance metrics

In April 2020, the CAQ issued a publication to provide a high-level overview of SEC requirements and guidance around non-GAAP reporting and the potential impact of COVID-19 on that reporting. The CAQ conducted a series of roundtables and noted that companies may use non-GAAP financial measures to describe the impact of COVID-19 in their quarterly and annual reporting and company management, audit committees, and investors find non-GAAP financial measures and performance metrics to be useful when they are calculated and presented consistently, transparently disclosed, and comparable to measures disclosed by other companies. Companies may adjust or tailor the non-GAAP financial measures and performance metrics they typically present because of COVID-19-related factors. It is important that transparent disclosure of how the metrics are calculated and why management finds these metrics meaningful be included in filings to help investors understand the effects of COVID-19 on a particular company.

Corp Fin provided guidance on non-GAAP financial measures and performance metrics used to describe the impact of COVID-19 in CF Disclosures Guidance: Topic No. 9, Coronavirus (COVID-19). In January 2020, the SEC provided guidance on the disclosure of key performance indicators (KPIs) and metrics in MD&A.

The CAQ publication summarizes SEC guidance related to non-GAAP financial measures, performance metrics, and the key components of the Topic No. 9 guidance related to COVID-19 and discusses the important responsibility that the audit committee has to oversee the financial reporting process and the external auditors. This resource is helpful for management as well.

The audit committee can act as a bridge between management and investors by:

The audit committee may consider the following when evaluating non-GAAP financial measures and performance metrics being presented to communicate the effects of COVID-19:

Goodwill impairment considerations in the COVID-19 environment

In June 2020, the CAQ published a resource intended to provide a high-level overview of management’s accounting requirements and auditor considerations for testing goodwill impairment in the COVID-19 environment. This resource is useful in considering the impact COVID-19 may have on certain aspects of accounting for goodwill impairment, such as triggering event identification and reporting unit carrying value and fair value calculations, as well as internal control considerations.

Going concern: Management and auditor responsibilities

In April 2020, the CAQ published a resource to provide a high-level overview of management’s accounting requirements under U.S. GAAP and a public company auditor’s requirement under PCAOB auditing standards related to going concern. As a result of the COVID-19 pandemic and the resulting economic uncertainty, several companies may face challenges that could impact their ability to continue operating as a going concern. Those challenges may include, among others, work stoppages, restrictions and/or regulations, supply chain disruptions, decreased commodity pricing, shut-in production, and reduced demand. To determine the effect of these challenges on the business, management may need to invest significant effort to prepare supportable future cash flow projections for the next 12 months that will be utilized in going concern evaluations. This may result in increased judgments by management and corresponding increases in skepticism from auditors with respect to going concern evaluations. In this environment, it becomes even more critical that management, the auditors and those relying on the financial statements have a clear understanding of each party’s responsibilities as it relates to going concern with respect to both the interim and annual financial statements.

Regulatory update: Other

Amendments to financial disclosures about acquired and disposed businesses

In May 2020, the SEC adopted amendments to the required financial disclosures about acquired and disposed businesses. The amendments will be effective on Jan. 1, 2021, but early voluntary compliance is permitted.

The amendments to the rules and forms are intended to assist registrants in making more meaningful determinations of whether a subsidiary or an acquired or disposed business is significant and improve the financial disclosure requirements applicable to acquisitions and dispositions of businesses.

Background

When a registrant acquires a significant business, other than a real estate operation, Rule 3-05 of Regulation S-X generally requires a registrant to provide separate audited annual and unaudited interim pre-acquisition financial statements of that business. The number of years of financial information that must be provided depends on the relative significance of the acquisition to the registrant. Three separate tests defined in Rule 1.02(w) are used to compute “significance:” the investment test, the asset test, and the income test. The relative significance of the acquisition or disposition then determines the period of the required historical and pro forma financial statements.

Article 11 of Regulation S-X also requires registrants to file unaudited pro forma financial information relating to the acquisition or disposition. Pro forma financial information typically includes a pro forma balance sheet and pro forma income statements based on the historical financial statements of the registrant and the acquired or disposed business, including adjustments to show how the acquisition or disposition might have affected those financial statements.

Amendments highlights

The final amendments will, among other things:

If you have any questions, please give our oil and gas team a call.

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