Editor's Note: The Public Interest Section of the American Accounting Association is pleased to publish the following blog post by Steve Mintz, Professor Emeritus, Cal Poly, San Luis Obispo. Please contact lawrence.chui@stthomas.edu with questions, comments, or suggestions about our blog, or to express interest in our organization. Disclaimer: When you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Accounting
and Ethical Guidance
Overview
In
the first enforcement action of its kind, the U.S. Securities and Exchange
Commission says The Cheesecake Factory falsely claimed its restaurants were
"operating sustainably" during the pandemic and it failed to disclose
the whole truth about the impact on its business. According to the SEC,
Cheesecake Factory's regulatory filings on March 23, 2020 and April 2, 2020
were materially false and misleading because the company failed to disclose
that it was losing about $6 million a week and hemorrhaging cash. It is the
first time the SEC has charged a public company over misleading disclosures
related to the pandemic. To settle the charges, The Cheesecake Factory agreed
to pay a $125,000 fine.
Operating
and financial disclosures are a key part of ensuring that the financial
statements are accurate and reliable and do not contain any material
misstatements. The failure to disclose all the information that an investor and
creditor needs to make their decisions is wrong. Earnings guidance for
investors and financial analysts should meet similar standards. From an ethical
perspective, honesty is about what you don't disclose as well as what is
disclosed.
SEC
Action
The
SEC's administrative action says The Cheesecake Factory in mid-March faced
"an unprecedent challenge to its business model as a result of the health
crisis and issued several disclosures regarding the effect of, and its response
to, the pandemic. Some of those disclosures failed to adequately inform
investors of the extent of the pandemic's impact on the company's operations
and financial condition in the period from late-March to mid-April 2020, when
the company secured additional financing," the Commission says.
During
this period, the SEC says, The Cheesecake Factory began taking steps to
conserve cash and increase short-term liquidity by, for example, informing its
landlords that it would not be paying April rent due to the "severe
decrease in restaurant traffic [due to Covid-19 that] has severely decreased
our cash flow and inflicted a tremendous financial blow to our business,"
noting that it hope[d] to resume our rent payments as soon as reasonably
possible."
The
SEC further states on March 2, The Cheesecake Factory filed a Form 8K and a
press release disclosing that it was "withdrawing previously issued
financial guidance due to economic conditions caused by the pandemic and that
it was transitioning to an 'off-premise model' - to go and delivery services -
that was 'enabling the company's restaurants to operate sustainably at present
under this this current model'". The press release further disclosed a $90
million draw down on its revolving credit facility, that it curtailed planned
growth, and that it was "evaluating additional measures to further
preserve financial flexibility."
The
company disclosed that, effective as of April 1, 2020, it had reduced
compensation for executive officers, its Board of Directors, and certain
employees. The company also announced that it had furloughed approximately
41,000 employees but allowed them to retain their benefits and insurance until
June and provided them with a daily complimentary meal from their restaurant.
Accounting
Issues
Since
the pandemic began, the SEC has encouraged companies to provide disclosures
that allow investors to evaluate the current and future expected impact of
Covid-19 through the eyes of management and to proactively revise and update
disclosures as facts and circumstances change. These disclosures should enable
an investor to understand how management and the Board of Directors are analyzing
the current and expected impact of the pandemic on the company's operations and
financial condition, including liquidity and capital resources.
The
disclosure involves a contingent event that, under generally accepted
accounting principles, should be evaluated whether it is probable that a
liability or loss will be incurred and the estimated amount of loss (record a
journal entry), it's only reasonably possible that a future liability exists
(footnote disclosure to the financial statements), or its highly unlikely that
any liability exists at the time the disclosure is made (ignore).
Auditors
also have to determine what, if anything, these disclosures mean to audit
firms' ability to render an unmodified (unqualified) opinion about The
Cheesecake Factory's results of operations. At a minimum, it would seem that a
going concern alert should be given by the auditors.
Ethical
Issues
The
SEC's actions send a clear message that Covid-19 disclosures will be carefully
scrutinized to ensure that they meet established standards for disclosures.
Companies that fall short of the mark expose themselves to SEC action that
could include fines and other penalties. The failure to disclose adequate
information about material events, such as the impact of Covid-19 on current
and future business, violates the rights of users of the financial statements
to receive full and fair operating and financial information about any material
events including:
- Whether disclosures are made on a timely basis
- The ability of the company to continue operating as planned (i.e., going concern).
- The effects of Covid-19 on current and future cash flows including the ability to pay off debts when due.
- The role of management and the audit committee in dealing with current and future effects of Covid-19 on operations.
Kant's
Categorical Imperative establishes the duties and obligations we have to each
other. Simply stated, it says, that you should act only in ways that you could
establish a universal law that to call something morally just it can be turned
into a universal maxim, on which everybody should uphold in a similar
situation.
There is no doubt that the public interest requires that a complete picture of the current and future impact of Covid-19 and its after-effects on the financial position and operating results should be made to accomplish the proper accounting response to the pandemic. Like anything else concerning disclosures, the devil is in the details. More guidance is needed by accounting standards setters to ensure the profession meets its ethical obligations to the public.