When a natural disaster strikes, the recovery can impact businesses long after they feel the initial damage and effects. Power outages, flooding, and property damage can lead to a loss of revenue and customers and increased expenses.
The most recent major disaster, Hurricane Ian, caused up to $70 billion in damage, according to a recent estimate from CoreLogic.
As CFOs assess the damage and plan for the future, it’s essential to know how to account for losses, business interruptions, and potential insurance recoveries. Proper tracking of costs will help ensure your company has the necessary documentation for insurance claims and government assistance. It can also be critical to ensure financial accounting and reporting are handled correctly.
Accounting for Insurance Claims
The accounting process for natural disasters starts long before disaster strikes, with a well-executed business continuity and disaster response plan. For example, if your business’s main operating location is destroyed, your plan might identify alternate facilities and equipment and how long your business can operate without access to servers and customer records. Addressing these plans in advance avoids making on-the-spot plans and assessments when operations and resources are strained.
When insured assets are destroyed in a natural disaster, the involuntary conversion guidance under ASC 610 should be used to account for the losses.
According to ASC 610, when a nonmonetary asset is involuntarily converted to a monetary asset (i.e., cash proceeds from an insurance policy), a company must recognize the effects of the conversion, even if it intends to reinvest the proceeds into a replacement asset.
For example, assume you have a building worth $1 million destroyed by a natural disaster, but it is insured for $900,000. Economically you incurred a $100,000 loss. For financial statement purposes, instead of recording the $100,000 economic loss, you will consider the book value of the property. If the book value of the building is $500,000, you record a $500,000 loss upon the destruction of the building. The insurance recovery is recorded separately as a gain. The timing of recording the gain depends upon several factors. The recovery of the book loss of $500,000 is recorded when it is probable that it will be received. Evidence to support the probability assessment may include communications from the insurance company regarding the claim or other claim-related information obtained prior to the final acceptance and approval from the insurance company. The $400,000 gain in excess of the book loss is recognized when contingencies are resolved, typically upon receipt of payment from the insurer.
Oftentimes the insurer will not pay out in the same year as the loss occurs. Therefore, you may record the loss in one year and the gain in the next, depending on the timing of when it is probable that the loss will be recovered from the insurer and your payout occurs.
Accounting for Repair and Maintenance Costs
While natural disasters can wreak havoc on our covered property, destroying them entirely, this isn't always the outcome. In many cases, you may need to account for reimbursements for repair and maintenance costs when the property is damaged but not destroyed.
If an asset only needs repairs to return it to its original condition, then these costs should be accounted for similarly to other maintenance costs. Just as if your building was destroyed, the repairs should be recorded both as a gain and a recovery. Costs of repair that are to be reimbursed from insurance are recognized as a gain when it is probable the insurer will payout for those costs. Any excess insurance recovery from the insurer is recognized when all contingencies are resolved, generally when the insurance payment is received.
As in the case of total destruction of the building, the timing of recognition of expense, the recovery of the costs incurred for repairs and any excess insurance recoveries may occur in different periods.
Accounting for Business Interruption Losses
An additional challenge CFOs may face is figuring out how to account for business interruption losses when a company is forced to temporarily close its doors due to damage from a natural disaster. Businesses continue to incur many expenses while operations are suspended after a natural disaster, including rent or lease payments, relocation costs, employee wages, taxes, and loan payments. Business interruption insurance helps businesses replace lost revenue or profits. This is often the largest component of insurance recovery and usually requires substantial negotiation and evaluation between the company and the insurance carrier.
Some business interruption policies may provide coverage for specific costs the company continues to incur while operations are suspended, such as salaries paid to idle workers and rents for property and equipment. When evaluating a potential insurance recovery receivable, these may be costs that have been recognized in the financial statements. Therefore, the insurance recovery may be recognized when it is probable they will be recovered, which may be before the final settlement is reached.
On the other hand, the absence of expected revenue or the loss of an opportunity for profit are not losses recognized in the financial statements. Under the gain contingency guidance, you cannot recognize anticipated reimbursements for these types of “costs” until all contingencies are resolved, which would be on settlement.
When faced with $70 billion of losses, insurance companies should be expected to have a long and careful diligence process prior to agreeing to any claims. You may need legal or other expert assistance to evaluate what is covered and ensure you’re adequately compensated according to the policy terms. We also recommend organizations affected by natural disasters consult with their accounting advisors to ensure accurate accounting and financial statement disclosures. If you need help getting started, connect with a member of our team.
Published on November 21, 2022