The Recession's Impact on the Accounting World
Helen Mallovy Hicks
Mike Walke, a partner with PwC and Audit and Assurance Credit Crisis leader, explores some of the key challenges to financial reporting in troubled times, and how to better manage.
Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.
Helen: And I'm Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.
Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today's hottest issues related to the economic crisis.
Dean: Welcome to PwC's Strategy Talks. In today's episode, "The Recession's Impact on the Accounting World," we are joined by Mike Walke, a Partner with PwC, in Audit and Assurance, Credit Crisis Leader. He'll be answering some questions on what some of the key challenges are to financial reporting in troubled times, and how we can better manage these. Welcome, Mike.
Mike: Thanks, Dean.
Helen: Mike, as Audit and Assurance Credit Crisis Leader at PwC, you obviously have a lot of direct experience with financial reporting issues during a volatile economy. What are some of the key areas of impact that a recession has?
Mike: We have seen a number of different issues in the current recessionary environment. The most fundamental is dealing with liquidity. As you both would be aware in your practice areas, Cash is King, and being able to generate sufficient amounts of cash and liquidity is a huge issue for many clients and businesses in general. There are implications with respect to debt agreements. Many debt agreements are cross-defaulted. As a result of covenant violations or potential covenant violations, companies are now looking at whether or not additional disclosures on liquidity is required, not only in the financial statements, but more broadly in their DNA.
How are they dealing with working capital deficiencies? How are they dealing with future cash requirements — whether it be pensions, commitments on fixed assets, forward agreements where they may have to fund collateral. All of these issues can have a huge impact on the financial statements. Debt classification in circumstances where long-term debt has been violated, the covenant has been violated. That might result in current liability classification. That current liability classification then brings on a whole series of other issues as to whether or not the company has a significant uncertainty with respect to its ability to continue is a going concern. That implication alone can give rise to a whole series of different disclosures that are required. What are managements' plans to address those issues? Along with that, as we deal with the liability side of the balance sheet and the potential cash shortfalls. As a valuator you will know that cash is an important aspect of valuing — per unit or in asset.
And in many respects, we're in an environment now where comparables are not available to look at. Many clients are now having to develop internal models that are very heavily dependant on assumptions, and on estimates which are difficult to audit, but difficult to prepare. Reaching out to third-party valuators is a key aspect of trying to deal with this issue. Looking at all the different disclosures that might be provided to make sure that users of financial statements or financial reports are able to assess the quality and the sensitivities of those valuation estimates. The other point I would make, is that impairments in general are very, very difficult because the accounting rules are so complex. Each asset line item has a different principal associated with it. Some assets are carried at fair value.
Fair value in a quoted marketplace is easy to determine, but often times as we've seen with asset backed commercial paper, it's dependant on (in a liquid market), dependant on management's own assumptions internal valuation reports. Other asset classes... deferred taxes have a different principal than long-lived assets, than does goodwill. Every one of them needs to be evaluated independently in order to determine whether or not an impairment or evaluation adjustment is appropriate. Those are the areas which we've been challenged with, and that we're trying to deal with our clients as business advisors.
Dean: Mike, in this environment, it must be pretty tough being an auditor. The risks of the economy and the uncertainties that are out there make it challenging for anybody to really get a handle on what tomorrow may bring. How are we approaching auditing in this uncertain environment?
Mike: This crisis came upon us very, very quickly. One of the things that, I think if you were looking back, who would have thought that the financial institutions (some of the most significant financial institutions in the world) would be in financial peril. So that, in of itself created the need for us to react very, very quickly. We identify the key accounting and auditing issues up front early, and engage the clients early on with respect to the key accounting and auditing issues. It would be reaching out the various different lines of services, whether it's our Valuations group, or our Tax group, with respect to tax-related issues. Looking to the expertise that we have in a particular industry, coupled with the disciplines that we have expertise in, can bring all of the resources that PwC has to bare on a particular issue — which will ensure that we will deliver the highest quality services.
Helen: We've heard that some company's in-house accounting professionals are dealing with greater budgetary constraints and have limited resources to carry out their responsibilities. In addition, you told us about a couple of key issues that are key areas of impact from the recession, being the liquidity and related disclosure issues, impairments and issues with value and goodwill. These are all new issues that often our clients don't really have much experience with. So they have more issues that they need to deal with, new issues that are more complex, and then on the other side they've got budgetary constraints, limited resources and lack of expertise probably in these areas. Is a downturn in the economy like this one, a good time to work with an external accounting and financial reporting advisor, or what do these companies do when they have limited resources internally to deal with all of these issues?
Mike: It's a great opportunity to reach out to professional advisors to assist them in dealing with some of these complex accounting valuation measurement issues and deal with preparation of their accounts. They do have limited resources, but on top of that, in the current environment, CEOs and CFOs of public companies as you know have to certify that their internal controls are operating effectively. And a key part of those internal controls is being able to do the proper analysis and come out with the accurate and proper amounts to record in their financial statements, and proper disclosures in the financial statements for them to be able to certify. So reaching out to a third party accounting advisor that has a multi-disciplinary approach — someone who can bring in special expertise in industry, in Valuations, in Tax - all of the various disciplines that we have here at PwC — To bring those to bare on a particular accounting issue or a particular set of financial statements can be very valuable.
Helen: So maybe tell us a little bit more, Mike, about what you're seeing with the regulators and their comments.
Mike: We have issued a couple of newsletters dealing with securities regulators comments, and in particularly appear to be focused on adequate disclosures, whether or not companies have addressed going concern assumption and related disclosures. Liquidity comes up time and time again, but impairments as well. They're all again very complex issues. We are able to assist our clients in dealing with these things: both as auditors and professional advisors. We should be involved in that process. We've discussed and have been able to help Boards of Directors understand what the issues are, and what the appropriate response, and if mediation is required, what those steps are.
Helen: How do you help your clients, because I'm sure they're reluctant to disclose these difficult liquidity issues, with the concern that too much disclosure or inappropriate disclosure may lead to additional problems. How are you helping your clients with that disclosure and navigate those disclosure issues?
Mike: We have seen, I would say in the last year, much less reluctance to disclose some of these issues, and for a couple of reasons. Number one, as I mentioned before — CEOs and CFOs are very cognizant of the reporting responsibilities, and that they now certifying, not only on disclosures, but on the operating effectives and internal control. And they're signing those certificates personally. So there's an added onus on CEOs and CFOs. So they're taking that reporting responsibility very seriously. Boards of Directors are also looking very, very closely at the types of disclosures, and are taking their oversight function very seriously, so there is a lot of debate within audit committees and I suspect at the board level as well, as to whether or not the disclosures around the company's liquidity position potential going concern issues are appropriately presented.
And finally, the accounting rules have changed, and in the last year there's been a couple of accounting pronouncements, section 3862 dealing with financial instruments — a liquidity section that requires some extensive disclosures. And also management has been required under new accounting pronouncement to specifically evaluate going concern. And that is required management in general to go back and deal with it.
It used to be going concern was considered the auditor's problem. But I think in the last two or three years with the advent certifications with the additional oversight we're seeing from boards of directors, in particularly audit committees as well as these new accounting pronouncements that many of our clients are very, very open to good robust disclosures on liquidity and in the unfortunate circumstance of a going concern very, very fulsome disclosures on their plans and trying to deal with these issues.
Dean: Mike, we've both had the opportunity I guess to speak with various board members of public companies and obviously the board's role is very different than management's role. We know one step removed from the day to day operations but they do need to get a handle on the risk and things of that nature. You know as we go through our year end audits and things of that nature where we are engaging with audit committees and boards, how are you seeing where boards are balancing that fine line of really getting a handle on what the situation is versus actually being involved in the day to day of the business.
Mike:Yeah, I think it goes through challenging management in the first instance. Is management producing the type of reports that they need? Are they getting adequate cash flow forecasts? Are they getting the information that they need in order to evaluate the situation? The other area that I think is important to remember is that — a public company's in a regulated world they have the Canadian Securities administrators looking over their shoulder. They've issued a number of comment letters. They've issued what we call a "Dear CFO" letter that says, "These are the issues that we expect you to be addressing in your public disclosures." The SCC is doing the exact thing with full force. So, boards as well as management are dealing in an environment where the regulators are looking at it and as auditors, we are also dealing with our regulators, whether it's the PCAOB and US reporters, or CPAB in Canada.
Helen: Mike, I see here we're almost out of time, here at Strategy Talks. So with our few remaining moments, is there one piece of advice you would like to leave our audience with?
Mike: Don't go at it alone. Reach out to either your auditors or professional advisors. The accounting rules, the disclosure requirements, they're all very, very complex. Reaching out to people who deal with this regularly, multiple times a year can only assist you in meeting your boards' expectations, the regulator's expectations, and minimize your risk of a re-statement or of a change in your disclosures, and minimize your overall risk in financial reporting.
Dean: Interesting suggestions, Mike. One last question. Give us your 30-second elevator speech on how you are helping your clients manage through these turbulent times.
Mike: Pro-activity. Being proactive on accounting issues, on disclosure issues, looking forward six months, twelve months. What are the issues that our clients are going to be facing? And how do we get in front of those and bring the appropriate expertise to bear. Again, whether it's industry, whether it's disciplinary, bring those people to the table so that they can evaluate what they need to do to address those risks and those issues early and upfront.
Dean: Thank you, Mike for being part of Strategy Talks today, and for your simple, honest and practical advice.
Mike: Thanks, Dean
Helen: To learn more about financial reporting and accounting issues in turbulent times, visit the PricewaterhouseCoopers Managing in a Downturn website at pwc.com/ca/managinginadownturn.
Voice Over: In the next episode of Strategy Talks, Dealing with your Banker, Helen and Dean talk to Vince De Luca, Managing Director of PwC's Corporate Finance Practice. Vince talks about how important it is for private companies to keep the lines of communication with their banker open at all times. Here's a sneak preview of what Vince has to say.
Vince: As the study indicates that over one third have not actually increased communication with their lenders throughout this time. So really, everybody's thinking that its business as usual, when and fact things have changed. There's more pressures on the banks, there's more pressures on the whole financial community.
Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, thank you for listening.
Helen: And I'm Helen Mallovy Hicks. We hope you'll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at pwc.com/ca/managinginadownturn.
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