Many organizations have recently entered into new debt arrangements to provide much needed liquidity either to weather the COVID-19 pandemic storm or to simply finance growth. Such arrangements involve many implications — technical accounting, operational accounting, investor relations — many of which will fall on the shoulders of the accounting team. Your team members will need to robustly document the accounting conclusions of the transaction while maintaining a strong control environment. The infrequency of debt transactions may result in a risk to accurate financial reporting. The following are steps to consider including in your financial reporting process when documenting debt raises in arriving at an appropriate accounting conclusion. These steps may also be modified to address other significant and/or unusual transactions.
Certain forms of debt may be new to your organization and management team and the accounting can be complex. It is important to obtain an understanding of the strategic objectives and the economics of the arrangements being considered followed closely by identifying the technical accounting requirements and the financial reporting implications. Thus, this first step may involve educating your accounting team on the technical accounting and disclosure requirements, as well as the impact to the company’s operational accounting procedures. Topics of interest for senior management to understand prior to executing the debt agreements may include the impact to earnings per share (EPS) for SEC registrants, as well as the impact to key financial metrics (such as adjusted earnings before interest, taxes, depreciation and amortization or “AEBITDA”) as used by investors and/or lenders. And if you are a SEC filer, don’t forget about your investor reporting team as they will be on the front line fielding questions from key external stakeholders.
Reviewing Transaction Documents
To be able to form an accurate conclusion of the accounting for the transaction, the team must first understand the relevant provisions in the underlying transaction documents. The best practice is to prepare an abstract of the contract documenting all of the significant terms.
Identify the Key Technical Accounting Guidance
While debt transactions are generally addressed by specific on point guidance, such guidance may be quite challenging to follow. Given the complex nature of debt transactions, all significant facts and circumstances should be considered in the accounting analysis. Start the process by thoughtfully reviewing the available accounting interpretative guidance and preparing an outline to assist in documenting the transaction. Do not underestimate the effort to properly document the accounting analysis given the various models within the accounting literature that may be involved.
Depending on the type of debt instrument, do not forget to consider the impact of COVID-19 on management’s judgments. For example, address whether the pandemic affected management’s assertion regarding the ability and intent to settle certain types of convertible debt with cash.
Document the Significant Accounting Conclusions
Once the accounting analysis has been completed, the accounting conclusions should be documented contemporaneously. A thorough accounting memorandum will include a summary of the significant transaction facts and circumstances, the applicable technical accounting guidance evaluated, alternative or contrarian viewpoints considered, if any and the basis for the conclusions reached. Robust documentation will also touch on the topics of the EPS impact for public companies, tax implications, and required financial statement disclosures.
Update Your Accounting Policy
While you are at it, consider formalizing your accounting policy around debt. And, if you are looking at convertible debt, do not forget to consider the future impact of the new accounting guidance, which reduces the number of separation models to one. The new guidance is expected to be effective for early adoption in fiscal periods beginning after Dec. 15, 2020. The accounting memorandum discussed within this article, if performed appropriately, should form the basis for a well-drafted accounting policy.
Document Changes to Accounting Operational Policies And Procedures
And finally, as always, document the impact to your accounting operations desktop procedures, as well as to your overall control environment.
For More Information
Many organizations may need assistance navigating the complexities of the accounting guidance related to debt transactions. Our CBIZ team of professionals are here to support the accounting teams of both private and public companies navigate and interpret the applicable accounting guidance, as well as aid in the preparation of accounting memorandum and other documentation that may be required. For more information on how we may help, please contact us.
Published on June 16, 2020