Accounting for War: The Impacts of Ukraine
As companies work to protect employees in Ukraine, they’re also making related adjustments in accounting and risk management. This week, Steve and Catherine are joined by Mike Ruble, an audit partner at PwC, to dig into issues from asset impairment to materiality to the risk of nationalization. Read the recap, or press play below to listen to the episode:
Season 3, Episode 15: Accounting for War The Impacts of Ukraine | Transcript
Steve Soter: Hello, and welcome to Off the Books, where we surf the uncharted waters of accounting, finance, risk, and wherever else the waves take us. This episode is brought to you by Workiva, the risk, reporting, and compliance platform that simplifies your complex work and creates order out of chaos. Check it out at workiva.com/podcast. My name is Steve Soter, accounting enthusiast and Diet Coke aficionado. I'm looking forward to debiting a great conversation and having you with us. I'm also happy to have Catherine Tsai joining me. Catherine, can you please tell the fine folks at home who you are?
Catherine Tsai: I'm not an accountant or Diet Coke aficionado, but I like asking questions, learning new things, and writing about them later. So I'm here to learn.
Steve Soter: Well, thank you, Catherine. As we've watched the tragedy unfolding in Ukraine amid the heartbreaking images of refugees and destruction, we also got to thinking, how were impacted companies accounting for all of this?
Catherine: Tsai That's right, Steve. And to help us walk through it, we connected with Mike Ruble, an audit partner out of Los Angeles.
Steve Soter: And before we get to Mike, let me add for the audience that we in no way mean to ignore or minimize the terrible human cost inflicted by Russia's invasion of Ukraine and the devastating impact to its citizens.
Catherine Tsai: One hundred percent, Steve. 100 percent. Let's now get to Mike Ruble.
Steve Soter: Well, we are delighted to have with us today Mike Ruble, trust partner in PwC's audit practice, to talk about some pretty interesting issues. Mike, thank you so much for joining us.
Mike Ruble: Thanks, Steve.
Steve Soter: Yeah, as I'm sure everybody is aware, of course, significant events happening in both Ukraine and Russia, and we got to thinking, OK, well, what does this mean for accounting teams and financial reporting teams? And Mike, we're hoping maybe you could break it down for us and for our audience. What are companies thinking about right now as they work through what are probably some pretty serious issues?
Mike Ruble: Yeah. Thanks, Steve. So, yeah, I'm Mike. I'm an audit partner in our Los Angeles Consumer Industrial Products group and started at the U.S. firm. Also spent about four and a half years, or five and half years actually overseas with PwC in Switzerland. So the questions there would be typical of most multinationals, which first off is, you know, "What do we do? We have operations in Russia, we have business units in Russia, we have plants in Russia, we have inventory in Russia. Like where do we start?" I think the the first and foremost thing is really the people, right? I think we can deal with the accounting, we can deal with the numbers. But the most important thing that our clients—and us as a firm, we have a couple of thousand people in that area as well—is making sure that the people are safe, both in Ukraine, the surrounding countries, as well as our Russian employees. So that's really been at the top of people's minds.
Catherine Tsai: So as you're taking care of employees, I'm sure there are some financial impacts from doing all of that. So how would you account for some of those impacts? What are some of the accounting issues people should be watching out for?
Mike Ruble: Yeah, thanks, Catherine. So I think we kind of see it in a couple of different buckets. Whether we like it or not, there are a fair amount of companies that do have experience with this recently during COVID. We had similar types of situations where you had closures of locations either permanently or temporarily. You had advances of compensation to employees. You were occasionally paying employees who weren't working. So I think generally at a high level, the guidance is sort of a push and pull towards two sides fighting against each other. On the one hand is if there's no service element. So if you're providing compensation to an employee but they're not required to work anymore, the guidance would say, well, you need to recognize that up front. There's nothing they have to do to earn that money, and so you should be expensing it right away. Alternatively, on the other side, under GAAP, you're not supposed to recognize expense now if there is going to be a future economic benefit from the services in the future. So that's sort of the pull side of it where you need to match your revenue with expenses. You don't want to recognize it too soon if they're going to be working in the future. I guess a good example would be, let's say you have a coffee shop, and you go out and you say, "Hey, you don't have to come to work. We don't think it's safe for you to come to work. We're going to keep paying your salary. You don't have to do anything, and you can go find another job, and you're going to get this payment anyways." That would be an example of where the guidance would say you should probably recognize that up front. Where if you were to say, "well, don't come into work now, but we don't want you to get another job because sometime in the next six months we might open, and we want you to be available." That would be an example of compensation you wouldn't want to recognize early, and you want to spread that out over the period. So that's kind of the push pull on the employee compensation.
Steve Soter: Mike, one of the other questions that I was wondering is you've kind of got two scenarios there. And first and probably the most critical, of course, is, you know, you're in Ukraine, you're in Kyiv. If I have physical assets there, obviously their value certainly will have been impacted by the war. But then on the flip side, if I had operations in Russia, customer-facing stores or whatever, and now I've pulled out, my assets are basically idle, kind of sitting around, I may have no idea when I'm going to go back in, and that could be months or I guess potentially years. Who knows? How are companies thinking through those two things where the value of something basically changed almost overnight and accounting certainly doesn't happen overnight. So I'm wondering, how are companies thinking about that and just kind of grappling with the reality of keeping the books clean as it were? So before Mike answers that question, let me break in here and explain impairment, which is a term that we'll use a lot in this episode. In a nutshell, impairment means that an asset's value has decreased below the value on its books.
Catherine Tsai: OK, so let's say I have a pickup truck for my business, and my ledger has it valued at $20,000. But then it gets in a wreck and is now only worth half of that. So I have a $10,000 impairment?
Steve Soter: Yeah, exactly. Now, of course, like everything in accounting, there is a lot more to that example, but you get the idea. In that case, you would recognize a $10,000 impairment, which would increase your expenses for that period and would decrease the truck's carrying value on your books. And this concept applies to pretty much any asset, whether it's a truck, a building, inventory, or something else. All right, with that in mind, let's get back to Mike.
Mike Ruble: You obviously have some impairment considerations if you have a damaged factory. You also are going to have to think about, am I going to be able to come back? Do I write off the whole thing? Do I change its useful life? Or do I just have an impact from certain cash flows with regards to, I have a sole supplier and that supplier is gone. Or my biggest customer—I have no idea when they're going to order again. Those are sort of the issues you deal with. And as you first start with, OK, what assets, what tangible assets, so AR, inventory, what kind of those assets do I have related to the business unit? And you go through that process for accounts receivable. So that's sort of step one. Step two is you then start looking at your tangible assets. So this is your property, plant, and equipment. So if we go back to the examples you were talking about before, if you have a plant or an asset in the country that's destroyed, you clearly expense it right away. If that plant has had some damage to it, but it's still usable, usually you then say, OK, do I have some sort of impairment or do I just need to adjust the depreciable life, right? If, for example, everyone's left the building and they may come back in the future in a relatively short order, and that plant I was originally going to expense over 10 years, do I now think I need to shorten that to five, for example, given the changes that are going on? And then lastly, do your goodwill impairment test. So you kind of do all that in a certain order and under the guidance. And that's kind of the framework you would walk through, Steve.
Catherine Tsai: Steve, we keep talking about impairment and steps. What do I need to know?
Steve Soter: Well, we're still talking about that same example of the truck. Except as you can imagine, some of this stuff can be very subjective and potentially manipulated. Like what if you fixed that truck with shoddy parts to save money, but then the truck wouldn't last as long? What Mike's talking about here are specific accounting rules so that companies use all of the same framework as they recognize impairments and to try to minimize anybody from doing anything shady.
Catherine Tsai: That's helpful. Let's get back to Mike,
Mike Ruble: And it's challenging, right? Because a lot of what we can say here, we can sit here and talk about the guidance and how you're supposed to do it. And getting all these inputs with all this uncertainty is really the challenge. But yeah, it's definitely not as easy as the textbooks, for sure.
Catherine Tsai: Well, that was going to be my question. How spot on does the asset impairment have to be?
Mike Ruble: Yeah. So generally, materiality plays a big factor into this. So the impairment has to be materially correct. When you're dealing with impairments, you're dealing with a lot of uncertainty, you're dealing with a lot of management judgments. I put my auditor hat on, and I'm always looking for objective evidence, which is always challenging to get. I mean, ultimately, it is a judgment. I think what we would give to our accountants is make sure you're getting outside of the accounting/finance organization to get some of these inputs. So your sales folks, they're going to know what customers are still buying, who's changed their buying patterns. Your supply chain folks are going to know what is the price of our inputs, how does that change? Or how is the supply and the shipping costs and receiving cost change. Making sure you get those data inputs into the model is going to come up with a much more accurate figure for what you think these valuations are worth as opposed to, you know, Mike, an accountant sitting in a room guessing. And so hopefully that answers the question. Materiality.
Catherine Tsai: Hi, Steve, it's me again. I think I understand what Mike means when he says materiality, but I know that determining materiality can be tricky. What do I need to know?
Steve Soter: So when Mike says materiality, he's really talking about a dollar amount applicable to a certain thing that a reasonable investor would care about. So let's go back to that truck example. Let's say that the damaged truck is only one of 1,000 trucks you have in your business. Well, I don't know many investors who are going to care about that $10,000 for a single damaged truck, so that clearly would not be material. But if it was your only truck and the only way you could stay in business? Well, then an investor is definitely going to care. It's actually both a quantitative and a qualitative determination. Is that helpful?
Catherine Tsai: Surprisingly, it is. Let's get back to the conversation with Mike.
Steve Soter: Well, and it's almost, you know, it's almost like it's a bit of a moving target initially. And I suppose, Mike, you can correct me if I'm wrong. But if the conflict, let's say, stabilizes and let's all hope that it does before the end of the year, then I think that would probably make it very easy for accounting teams to dial into some level of accuracy. But I'm picturing, you know, heaven forbid, the conflict lasts beyond 2022. Well, I have a period ending, presumably at the end of the year. Now I may have to make those determinations that would be subject to an auditor like yourself. And again, that may be somewhat difficult to do, as it kind of was in the early days of COVID, simply because I don't know how this thing is going to play out.
Mike Ruble: Yeah, that's exactly right. And no one has a crystal ball, and you somewhat have to deal with what you know as of the date you're making these estimates. So for example, one of the things we talked about a lot is kind of this worst case scenario for U.S. companies in Russia, which is nationalization, which has happened in Venezuela. It's happened before, before my career started. It happened more frequently in sort of the '60s, '70s, and '80s.
Steve Soter: And to clarify when you say nationalization, meaning that the government basically comes in and says, Hey, these are no longer owned by you as a private business, we are now going to take ownership of those assets. I mean, simply said, is that what you're referring to?
Mike Ruble: Yeah, that's exactly right. And that's a risk. I think, in Russia there's some bills currently in parliament to do that, and it could happen in the Ukraine as the country recovers from war that, you know, to Steve's point, hopefully this turns around and they begin their rebuilding process. But you see this in countries rebuilding. And that's an example of, as of now, no one knows what's going to happen with regards to that. So you kind of have to go with what you know as of the date. And you know, as of now, it looks like there isn't really a significant end for the conflict. So that's kind of where you have to position yourself as you're closing your fiscal Q1.
Catherine Tsai: We are going to close the first half of this conversation with a short message from our sponsor. We'll be right back.
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Catherine Tsai: Welcome back to our conversation with Mike Ruble talking about the accounting impacts of the war in Ukraine.
Steve Soter: It's interesting to think about accounting teams having to make potential guesses and informed guesses, but potential guesses about, well, latest intelligence is that the conflict is going to last this long, and then after that, it's going to take that long to rebuild. And I don't mean to make light of what is obviously a very tragic situation. But you know, some accounting determinations are going to require future estimates. And at least in this case, you sort of have to have an assumption of how long is this going to last and how bad is it going to get in order to accurately make those. And I'm just picturing myself in accounting, you know, looking at latest intelligence reports and, you know, here's what the boots on the ground are saying. That's a very odd situation, I think, for accounting teams to find themselves in.
Mike Ruble: Yeah, that's right. And it was very similar to where we were, I remember, you know, closing Q1 of 2020 and where we were with COVID. Right. And it was the same situation where no one had any idea of what COVID was going to do and what was next. I think, you know, outside of just the accounting, you also have, you know, if you're a public company, executives out there providing guidance, right? And they're also not knowing where it's going to go. So it is a management judgment. And that's why I think what we generally give is just get outside of accounting and finance as much as you can to get those data, those independent data points. And then if you're a public company or a company that provides MD&A, just disclosing how you got to your conclusion. How did you decide what should be impaired, what shouldn't be impaired and providing foreshadowing language if you're worried about something in the future that's really uncertain. I mean, that's generally how companies would deal with that amount of uncertainty as disclosures.
Catherine Tsai: Steve, are you tired of these questions because Mike was first talking about accounting guidance, but now I think he's talking about another type of guidance. Plus, when he said disclosures just now, was he talking about 10-Ks?
Steve Soter: So, Catherine, you know, more than you think. Yes, at the beginning of our conversation, Mike was talking about accounting guidance, which are the rules that accountants use to record things. But just now he's been talking about earnings guidance, meaning the estimates that companies will give to investors about their expected revenues or maybe their profitability, things like that. So what he's saying just now is that for things like COVID or the tragedy in Ukraine, it can be really hard for companies to give that guidance on future revenue or profitability because there's just so much uncertainty. And whenever there's uncertainty like that, you definitely want to disclose all of those uncertainties to investors in places like 10-Ks, 10-Qs, or earnings releases. That's really what he means there.
Catherine Tsai: We've talked a lot about uncertainty. Which kind of naturally goes into the topic of insurance. So do companies have insurance for incidents like this?
Mike Ruble: I think generally most of our clients do. I would kind of break it into two groups of insurance. One is for losses of tangible assets. So factories, warehouses, inventory, you know, physical types of assets they own. And then the other one, the big business interruption insurance that many of our clients also have for these types of events. And generally speaking, what I've seen is that our clients often will get some sort of communication from the insurance provider saying, yes, this is a covered claim. Yes, you have a valid policy. And that's what they then use before they book any sort of receivable for that. Business interruption is a little bit different because in business interruption, it also covers not only the covering costs, but it also has usually there's a margin included in it. So you're going to get this business interruption insurance that's not just going to cover your direct costs, it's going to include a profit. That all said, most insurance contracts for many things, including houses and cars that we own on a personal standpoint, they generally have, you know, acts of war force majeure elements in them, which invalidates the contract based on those criteria. I'm not an insurer. I can't speak on behalf of the industry. But, you know, I would think in this situation that is a risk, right? That the losses may not be covered by your insurer, given their nature. So I think heading into this quarter, I think it'd be even more important if you do have actual losses to have your insurer provide you in writing that this is a covered claim, that the assets are covered, that they've gone through their process because I think you'll probably run into issues where they will potentially this is not covered claims due to the nature of their costs.
Steve Soter: Always the insurance companies, they're always trying to find a way out.
Mike Ruble: Yeah, well, that's why our rates are so cheap, so.
Steve Soter: Well, not to geek out too much on the accounting, but I would say that, just as an observation for our listeners, is that as we've heard, there's a lot of uncertainty with respect to what you can actually recognize, what you can record versus other things that might be out there that could impact things one way or the other, but that I can't record. And that's where the disclosure, saying, "Hey, I can't record this or recognize this in my books, but these other things are hanging out there that you, financial statement users, should be aware of, because that might change your perception of where we're at as a company in terms of our financial position."
Mike Ruble: That was very geeky. You're right.
Steve Soter: You're welcome.
Catherine Tsai: Are there any other accounting issues that we're missing that companies should be watching out for?
Steve Soter: So, Catherine, before Mike answers, let me provide a quick explanation of a term he's about to use, which is consolidation. As you would expect, large companies are often made up of smaller companies that are consolidated or put all together for a financial reporting purpose. But as Michael explained, If you sell or lose control of one of those smaller companies, well, then you would de-consolidate it and no longer include that company in your financial reporting. All right, with that in mind, let's get back to Mike.
Mike Ruble: Oh, yeah. It really depends on your business. I mean, I think one of the other things we've been thinking about are consolidation. I think there are certain types of industries where there are threats of either nationalization, which we talked about before, or just simply losing control of the business. And the best sort of way I've seen this described in the past is, if management really no longer has the ability to exert control over the subsidiary, that's when you need to think about "Should I continue to consolidate this entity in my accounts, or do I need some sort of other accounting for it?" And the way that's demonstrated is things like being able to pull profits out of the business. So you think you have a subsidiary in Russia, and it's earning profits, and you want to pull the money out of that profit they're making, pull back to the center and redeploy the capital. If you can't do that, then— that is the most important part about owning the subsidiary is being able to pull the profits out. So if you can't do that, that's a problem, right? Other things are, you know, you can't contact local management there. They won't provide financial information to you anymore. Political uncertainties. We've seen a lot of certain things done by various jurisdictions related to embargoes and asset forfeitures and those types of things.
Steve Soter: Well, certainly a lot to consider. And you know, I think it's interesting to just hear from you, Mike, how these very critical and troubling and chaotic world events actually sort of make their way into the books and records of companies that naturally have to account for, record, and disclose all these things. So again, hope that we don't have to deal with these issues for much longer and of course, that the conflict resolves very soon.
Mike Ruble: Yeah, that's yep, that's correct. And as we started with, I think most of our clients and us, I think, have really tried to lean into the people side of it and really deal with that as the most important thing. And as mentioned, the accounting is important, but you know, the emphasis has got to be on the people first. So, yeah, thoughts and prayers with them.
Steve Soter: Well, we generally try to lean into the people side of things at the end of our podcast with a closing question of the day. This one is going to be very boring so that we don't make too much light or humor of this topic. Mike, have you seen any good movies lately?
Mike Ruble: Um. It has been busy season, so movie watching has been somewhat limited. I guess my wife and I did see Murder on the Nile a couple of weeks ago. That was actually pretty good. And I think it's somewhat like an asset impairment. It's somewhat of a whodunit mystery. And sometimes when you're dealing with asset impairments, you never know whose fault it was. And so, you know, it was a good flick.
Steve Soter: It's the auditors' fault. It's always the auditors' fault.
Catherine Tsai: Well, I'm Googling Murder on the Nile, and it says it's called Death on the Nile.
Mike Ruble: Oh yeah. See, that's how much I was paying attention. It was called Death on the Nile, and apparently even the title was a mystery.
Catherine Tsai: It sounds promising. I'll have to check it out.
Mike Ruble: Definitely. I probably just gave it away that I said it was Murder on the Nile. It was not a death by natural causes on the Nile.
Steve Soter: Oh, that's good stuff. Well, Mike, we appreciate you coming by and joining us. Again, it'll be interesting to see how this plays out. And totally agree. Thoughts and prayers are obviously with everybody who is just going through a horrific experience in Ukraine. We again appreciate your insight. Thank you.
Mike Ruble: Yeah. Thanks, Steve. Thanks, Catherine.
Steve Soter: Well, that wraps up our conversation with Mike Ruble. Big thanks to him for dropping by and explaining these issues for us.
Catherine Tsai: And thanks to you, dear listener, for surfing along with us. Our hearts are with the people of Ukraine amid the horrific tragedy they have endured. I'm Catherine Tsai, that was Steve Soter, and this has been Off the Books, presented by Workiva. Please subscribe. Leave a podcast review. Tell your buddies if you liked the show, and feel free to drop us a line at OffTheBooks@workiva.com. Surf's up, and we'll see you on the next wave.