As the COVID-19 pandemic continues to sow chaos and disruption, SEC registrants need to evaluate the impact of the pandemic related to multiple aspects of financial reporting, including the quality of disclosures.
Audit Analytics has discussed some of the tangible impacts of COVID-19 in the past, including going concerns, impairments, late filings, and litigation. But the pandemic has impacts far beyond any projected monetary impacts or risk factors included in a company’s financial statements.
An important aspect of high quality financial reporting is disclosure controls, which are the controls and procedures in place to ensure that information that must be disclosed is accurately and timely recorded, processed, summarized, and subsequently reported in SEC filings. As the SEC has noted, registrants are required to include, as a part of their disclosure control assessment, information about significant changes in internal controls over financial reporting (ICFR), as financial reporting is considered a subset of the public disclosures that a company is required to make.
To maintain an ongoing effective control structure, SEC registrants are required to assess their controls and disclose any changes in internal controls over financial reporting on a quarterly basis. Any internal and external changes in the environment or operations that could materially impact the internal control structure, business, or financial statements must be monitored and assessed, as required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act. Internal controls may be materially impacted by changes caused by the COVID-19 pandemic and, therefore, the COVID-19 impact on internal controls must be assessed as a component of disclosure controls.
The SEC’s Office of the Chief Accountant addressed the importance of controls in light of the pandemic in a statement on June 23, 2020:
“If any change materially affects, or is reasonably likely to materially affect, an entity’s [internal control over financial reporting], such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred (or fiscal year in the case of a foreign private issuer).”
When looking at SEC-registered public companies that trade on a major exchange and are required to adhere to SOX 302 requirements, 935 unique filers have included a reference to COVID-19 in their disclosure controls since March 2020 – equating to 9% of SOX 302 disclosures filed in that time frame.
It is unlikely that the COVID-19 pandemic itself would result in ineffective controls, but the adjustments made in order for a registrant to continue to operate during the pandemic may warrant further scrutiny in terms of control structure.
The COVID-19 pandemic heightens the risk for controls to operate ineffectively; established controls may not be equipped to handle remote work and there are potential consequences associated with operating and testing controls amidst reduced personnel. Some companies have noted the potential for issues in their control procedures, including issues related to a remote workforce and reduced personnel, in addition to noting material changes to procedures arising from the pandemic and difficulties remediating existing material weaknesses.
General Changes to Adjust for Remote Workforce
For many registrants, the COVID-19 pandemic prompted a review of procedures to determine if a change in controls was necessary due to a new remote workforce.
Some companies disclosed that a change occurred in internal control structure as the result of employees working from home, including Alphabet [GOOGL] and Johnson & Johnson [JNJ], but primarily these changes were “precautionary actions to re-evaluate and refine” the financial reporting process through additional monitoring controls.
Other companies, including Intel [INTC], disclosed that business continuity plans were activated to reasonably ensure that financial results are reported accurately and timely.
Assessing Heightened Risks of Remote Workforce
An impact of the pandemic on controls is associated with the heightened risks that the pandemic poses on accuracy and completeness of financial reporting through digital means while employees work from home. For example, Honeywell International [HON] disclosed the enhancement of oversight and monitoring during the close and financial reporting process, in addition to investing in expanded digital security and higher scrutiny and monitoring of cybersecurity threats while employees work remotely.
Some companies, such as Walgreens Boots Alliance [WBA] and Gannet Co. [GCI], disclosed that their controls were not developed or designed to accommodate a shift in employees working from home, but concluded that changes to the working environment did not have a material impact on controls.
Segregation of Duty Concerns Related to Reduced Personnel
Deficiencies in controls can be related to the number of qualified accounting personnel that a company retains. As many companies are decreasing their workforce in the difficult economic times of the pandemic, issues may arise that impact the ability of a registrant to maintain segregation of duties.
The lack of employees, or the ability to retain and compensate a workforce, has affected some SEC registrants. For example, Arts Way Manufacturing Co [ARTW], disclosed that if their workforce continues to decrease due to COVID-19, difficulties maintaining proper segregation of duties may arise.
Material Changes to Procedures
While many impacts related to controls are indirect, some companies have disclosed more material changes. For example, Home Depot [HD] disclosed that, as a result of COVID-19, physical inventory counts were temporarily suspended and that inventory shrink reserve would be updated based on historical results, until physical inventory counts can resume.
Inability to Remediate Material Weakness
For other companies, such as Net Element Inc [NETE], the pandemic prompted a reallocation of resources to mitigate risks associated with controls. However, Net Element disclosed an additional concern that the Company will not be able to timely remediate the material weakness in their controls related to its decentralized structure used to manage operating activities with international operations. Net Element cites uncertainty about the pandemic and ongoing travel restrictions that may prevent necessary actions from being taken to remediate the weakness.
While some registrants have disclosed more information related to the impacts of COVID-19 on controls, many included a generic disclosure stating that management would continue to monitor and assess the COVID-19 situation on internal controls to minimize the impact on their design and operating effectiveness. However, considering many control structures were designed prior to the pandemic and the adjustments required to continue operations, such as a remote workforce, it would not be surprising to see increased disclosures regarding material changes to controls in relation to the pandemic.
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