The COVID-19 crisis has changed every aspect of our lives, from how we work, interact in public, socialize and stay connected – nothing has been untouched. Recently I reached out to my friend and colleague, Mike Tresidder, at the Insurance Office of America, to check in. (This may have taken place during a virtual Happy Hour, but I will not bore you with those details.) Mike is a Surety professional who specializes in construction.
Mike and I talked for quite a while. Eventually we started discussing business and how this world wide event is going to change the macro economic landscape in general. Then we started to drill down on how it might affect our industry and the clients that we work with. The interdependent relationship between our two chosen professions is quite profound.
We thought others might benefit from the insight we discussed, through the lens of a Surety professional and CPA. We decided to capture our conversations in written form in the hopes that you will benefit from our discussions. Over the next few weeks we are going to release short pieces on the main topics that we went over. Our hope is that you will gain perspective from both the CPA and Surety point of view as we all navigate these unprecedented times together.
Part I – Mike and I got talking about …
Contractor: “Where’s my BOND?”
Surety: “Where’s my FINANCIAL Statement?!”
Bob’s Comments from a CPA’s Perspective:
Since mid-March, the Country has largely been on lockdown. Only essential businesses are being allowed to operate. Even if you are an essential business, like construction, the guidance on what job sites are allowed to operate seems to change daily. Accounting has also been deemed an essential business and allowed to continue to operate. This means that your CPA should be cranking out your year-end financial statements and tax returns like normal, right?? Well, not exactly …
Strictly speaking from our firm’s protocols, anecdotally what I’ve heard from other firms across the country and comments from the AICPA, business is anything but usual at your CPA’s office. About 80-85% of our professional staff are working remotely to adhere to social distancing guidelines and as a precaution to keep our employees safe. In addition, most office staff at contractors’ offices are also working from home. While we are adept at working remotely as a general course of business, not having access to the office and working with clients that are not used to working remotely, has slowed down the process of audits, reviews and compilations.
If field work for the year-end financials was not completed before the quarantine was implemented, you can expect a delay in the issuance of those financial statements. Doing an audit or review remotely is certainly possible. However, when you request supporting documents from the client, there could be a time lag in getting a response if the client’s accounting staff is also working remotely. In some cases, accounting staff are only going into the office once a week to maintain social distancing protocols.
Financial information and the CPA process (displayed below) is akin to an assembly line.
A delay in the issuance of the financial statements will trickle down to a delay in the tax returns and personal financial statements.
What does all of this mean?
The financial statements are historical documents. They do not tell you anything about what is going on today in this current economic crisis. In general, the farther you receive the financials from year-end, the less relevant the information is. So receiving financials that tell you a story about how the contractor performed in arguably the best economy the Country has ever seen, while the current state of the economy has over 22 million jobless claims in four weeks and at one-time a decline in the stock market of approximately 30%, leaves a lot to be desired.
CPAs will have to rely on Subsequent Event disclosures to relay relevant “real-time information” to the financial users.
Examples of those types of disclosures include:
- Disclosures should be made that indicate the current events will have an effect on future earnings, even if it is not measurable at the date the financials are issued.
- If the Company holds a significant investment portfolio and the declines in the portfolio are material at the date of issuance, those declines should be disclosed.
- Another possible disclosure would be if a major customer had been significantly impacted by the economic downturn such that the earnings from the contractor would be negatively impacted going forward. Credit and collection issues are a reasonable expectation in the current environment.
Due to the above issues, I believe sureties and other users of the financial statements will require interim financial statements. These financials will show a drastically different picture when compared to year-end and any year-over-year comparison of other interim periods. I also believe that presenting backlog, even with interim statements, is very valuable; perhaps critical in these circumstances.
Lastly, contractors with fiscal year ends such as June 30 or September 30 will probably have their working capital and earnings significantly impacted as the reporting period will include the current downturn.
Mike’s Response from a Surety Perspective:
You hit on some great points, Bob. I certainly believe the surety industry agrees with accounting being deemed essential. In the current rapidly changing environment that all businesses are dealing with, I agree with your assessment of some expected delay in receipt of CPA financials, interim statements, and tax returns.
I’m sure sureties will see the gamut as far as the length of time for receipt of year-end information based upon the various factors described above. I have seen a few subsequent event footnotes in CPAs’ year-end financials we have received thus far and would expect to see an increasing trend on this front.
These are very challenging times for many contractors. I believe we may see a flexible approach taken by many sureties from a timeline standpoint with the receipt of year-end statements along with any interim financial statements. More specifically, given that many contractors do not necessarily show well in our territory during the first 3-6 months of the year (think heavy highway and site contractors) during normal times, the true impact may not yet be fully realized until the latter half of 2020. As the year progresses, I would expect to see sureties being diligent in requiring interim statements given the high level of uncertainty that lies ahead.
You also have a great point on the off-year end contractors (6/30 – 9/30) potentially being negatively impacted. I believe a surety underwriting focus will be fully understanding the Why. Were the results poor due to COVID-19 or underlying operational and performance issues?
“So Mike – with such huge declines in the stock market, how is a Surety going to view the investments a company may hold on the balance sheet?”
… To Be Continued. Click here for part two in this five-part series.