From WSJ: Finance chiefs and investors are trying to figure out how to account for coronavirus-related expenses as the pandemic transforms how companies operate in ways that may become a permanent cost of doing business.
Businesses have spent billions of dollars on personal protective equipment, such as masks and gloves, to keep their operations running since March. Many have retrofitted office spaces and factories to protect workers. Stores and restaurants have added plexiglass dividers, reduced capacity to allow for social distancing and paid employees special bonuses to continue doing their jobs on site when remote work isn’t possible.
More than six months into the pandemic, company executives say they expect to be dealing with the effects of Covid-19 for much longer than they initially anticipated.
Still, some companies continue to treat virus-related costs as special, one-time items, which can give the impression that a business’s costs are lower than they actually are. This in turn can boost its non-GAAP financial results. Companies often highlight these metrics when also reporting earnings figures that comply with generally accepted accounting principles as required.
Some investors and accounting professionals suggest that after two quarters of reporting Covid-19-related costs, companies should consider treating these items as regular costs of doing business as they close the books for the third quarter and not adjust their non-GAAP earnings.
Such thinking is based on the Federal Reserve’s projection that the U.S. economy won’t recover fully until there is a widely available vaccine, at which point, PPE, social distancing and other Covid-19 precautions may become unnecessary. Such a vaccine, however, might be months, if not years away. And companies are likely to keep incurring coronavirus-related expenses until then.
“The pandemic isn’t something that could be characterized as a discrete event,” said David Knutson, vice chair of the Credit Roundtable representing institutional investors and head of credit research for the Americas at Schroders PLC, the asset-management company. “Presenting a one-off adjustment in what is a secular change is misleading,” he said, adding that in some industries, there won’t be a return to pre-Covid-19 times.
Boston-based Iron Mountain Inc., an information management-and-storage company, in the second quarter booked $9.8 million in Covid-19-related expenses for personal protective equipment, plexiglass shields and cleaning. Iron Mountain added those costs back to its adjusted earnings before interest, taxes, depreciation and amortization, a metric it uses to demonstrate its ability to generate cash flows.
“We were very conservative and prudent in terms of what we added back in,” Chief Financial Officer Barry Hytinen said. In the footnotes of its financial statements, Iron Mountain says Covid-19 costs are “not expected to recur once the pandemic ends.”
The Securities and Exchange Commission prescribes that companies reconcile their non-GAAP results—which may be adjusted to exclude certain, one-time and nonrecurring costs or charges—to the nearest metric under generally accepted accounting principles. “When we see recurring nonrecurring charges, they should be treated as a cost of doing business instead of being ignored,” said David Zion, head of accounting and tax research firm Zion Research Group.
Finance executives in recent years have adjusted earnings more frequently. In the second quarter, 94% of companies in the S&P 500 used at least one non-GAAP measure, according to data provider Audit Analytics.
Such adjustments can be small change. But sometimes they can help turn a billion-dollar loss into a profit.
DuPont de Nemours Inc., the specialty products company, in the second quarter reassessed some of its assets in part due to the change in economic outlook, and found that the transportation and industrial unit’s book value was about $2.5 billion lower than previously recorded. That and other items led to income adjustments for the company, which reported a non-GAAP income of $514 million, instead of a loss of more than $2.4 billion.
The Center for Audit Quality, which represents public-company auditors, reviewed a sample of second-quarter earnings releases and found an increase in the dollar amounts of non-GAAP adjustments compared with before the pandemic. Among the more common were adjustments for hazard pay or Covid-19 bonuses, PPE charges, and incremental sanitation and cleaning costs, said Dennis McGowan, senior director of professional practice at the CAQ.
The SEC in March issued guidance requesting companies to provide explanations when they use non-GAAP measures to adjust for the impact of Covid-19. “It would be appropriate to highlight why management finds the measure or metric useful and how it helps investors assess the impact of Covid-19 on the company’s financial position and results of operations,” the agency said at the time. It declined to comment further on its guideline.
Ebitda adjustments for virus-related costs also have become a point of contention between companies and lenders. Businesses that have term loans or revolving credit facilities have to meet certain financial targets, or covenants. Adding back certain costs or charges can boost a company’s adjusted Ebitda, therefore making it easier to comply with those requirements, said Janet Vance, a partner at Gibson, Dunn & Crutcher LLP, a law firm.
“We have seen some lenders who are sensitive to these add-backs,” Ms. Vance said.
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