I got an email alerting me to some recent PriceWaterhouseCoopers publications.  Their Transaction Services group appears to be writing a series of papers on Financial Reporting in a Troubled Economy.  One report in particular caught my eye – “How the Economic Slowdown Leads to Added Financial Reporting Complexities.”  An interesting quote is “While financial reporting can be complex even in the best of times, many transactions and the attendant reporting issues can be even more daunting during troubled economic times and the recovery period that follows.”

This got me thinking– what sort of transactions/issues will become big financial reporting issues due to the financial crisis? Specifically, I expect the crisis to be the sort of “shock to the system” that allows researchers to examine issues that do not arise in times of prosperity or well functioning markets. In other words, it provides much more variation in some independent variables, and by exploiting the additional variation, researchers might design more powerful tests of important questions. Perhaps a discussion along these lines will help bloggers to frame some interesting questions.

The PWC report lists several issues that require heightened attention during a crisis. The ones I might have guessed are

  • Bankruptcy reorganizations – additional reporting issues arise while the reporting entity undergoes bankruptcy. (The auditor also has to consider going concern issues, but this report is aimed at preparers.)
  • Asset impairments – impairment triggers are more likely to be tripped in a downturn, and once the triggers trip, full impairment testing is required.
  • Fair value measurement of financial instruments – when / how to assess fair value in distressed markets.
  • Derivatives and hedging – assessing fair value and hedge effectiveness can be a challenge in a crisis. Also, the increased market volatility may lead to new hedging activity.
  • Debt restructurings or repurchases – some borrowers are either refinancing their debt or bargaining for better terms; the amount of gain from settling or restructuring troubled debt can vary significantly depending on how the transaction is structured.
  • Deferred income tax asset valuation allowances – if recent company performance is poor, the recoverability of deferred tax assets is called into question. 

The report had several other issues I would not have thought of are:

  • Lease restructurings – what happens when a company modifies the terms of its leases?
  • Private investment in public enterprises (PIPE) – I am not quite sure what this is, unless it is an infusion of capital into a public company from some private equity fund or other such sources. The report suggests that such financing usually comes with embedded derivatives and implications for earnings per share.

I can think of one category that is not in the report – how should a public company report its acceptance of government “bailout” funding? How does the reporting entity decide whether the credit side of the entry is debt, equity, or income?

The three page report is on cfodirect.pwc.com.  If the link above fails to open, then you might need to sign up for access  (I believe academics can sign up for free);  send me an email if it does not open.