Financial reporting after a natural disaster
By Michael Cohn
The recent string of devastating hurricanes and wildfires in the U.S. and its territories has prompted questions about financial reporting by companies striving to recover from natural disasters while wrestling with their insurance companies over damage claims.
“We do see a number of questions that typically come in when you have events occur,” said Dennis Howell, a senior consultation partner in the Accounting Services Consultation Group in Deloitte’s National Office. Deloitte recently released an alert discussing the financial reporting implications of disasters for organizations using U.S. GAAP.
“A lot of these are primarily related to companies that have incurred losses, and they’re really just trying to determine what type of insurance recovery they may have," Howell added. "Part of the challenge is determining first of all the type of loss that a company has recorded and is it even covered by your insurance policies. And if it is covered by your insurance policies, then what we typically see is companies apply what they call a cost recovery model.”
The accounting literature essentially requires companies to first report a loss for any type of damage related, he noted. “These are typically a plant destroyed or certain costs may be incurred that otherwise wouldn’t have been incurred because of a storm,” said Howell. “Then the company would need to separately assess whether they have an insurance recovery.”
Sometimes that process may require some legal analysis because the situation isn’t always perfectly clear. “Companies may have to determine why the damage was caused,” said Howell. “Was it caused, for example, by wind or was it caused by flood? Flood may not be covered, but wind may be covered. Both may have occurred, but they have to determine what type of loss would have been covered by their policy.”
Businesses may find themselves embroiled in a dispute with their insurance company. “Insurance companies may not agree that type of loss was covered, or there may be a dispute as to whether it was really caused by wind if, for example, flood damage isn’t covered,” said Howell.
He pointed to longstanding guidance on separately recording an insurance recovery. “If the dispute is being contested, then there’s been guidance in the accounting literature as well as from the SEC staff that there’s generally a rebuttable presumption that an insurance recovery should not be recorded if there’s a dispute,” said Howell. “If a company overcomes the rebuttable presumption, in other words, if they record some type of insurance receivable, even though there may have been a dispute, then I think the SEC staff would expect disclosure of the fact that there could be contested coverage. The company notwithstanding that still records a receivable or a recovery, and then discloses in its notes the nature of the dispute, the type of insurance that has been recorded and what have you.”
Businesses may need to consider impairments too. “Companies may have fixed assets that have to be impaired,” said Howell. “If they had complete destruction of a business or significant loss of a business, and if a company had recorded goodwill, you may need to assess whether that goodwill should be impaired. If you have a receivable that may have been impacted by some of these storms, you have to assess whether those receivables continue to qualify for collectability.”
The proper classification of losses on the income statement is also important. “U.S. GAAP does require that if you meet certain criteria that could be considered unusual, then you would need to specifically call out that loss on the face of your income statement or in your disclosures,” said Howell. “But the loss would have to qualify. It would either have to be unusual in nature, or infrequent in occurrence. One of the things the accounting literature talks about is that you have to consider the environment in which the entity operates. For example, if you’re in Florida and a hurricane hits, that may not qualify for the classification of unusual in nature or infrequent in occurrence. When you’re looking at something that is unusual in nature or infrequent in occurrence, the magnitude of the loss does not necessarily drive that conclusion, so while it may be a significant loss, it may not necessarily be indicative that something is unusual or infrequent in occurrence.”
However, even if companies don’t meet the technical criteria for separately calling that out on the face of the income statement, most likely they should be reporting in their disclosures the nature of the losses. “In other words, if you had a goodwill loss, there’s already specific disclosure requirements for asset impairments, for example,” said Howell. “If you record an insurance receivable, even if it’s not disputed and if it’s a material amount, those types of transactions most likely would warrant disclosure. But even if it is disputed, then historically there have been requirements that companies need to disclose the fact that insurance coverage may be disputed.”
Companies may also have environmental issues to consider. “In the Gulf area, you may have underground tanks that could have been damaged,” said Howell. “Or there could be damages that caused leaks from natural gas. Companies may be required to look at whether they have environmental liabilities that they may need to consider reporting, which would potentially require disclosure. If you’re a public company, an SEC registrant, and if you have a material loss from these natural disasters, I would imagine that the SEC would be expecting these companies to have transparent disclosure on the types of losses they had.”
The Financial Accounting Standards Board’s Emerging Issues Task Force clarified some of the guidance on recording insurance recoveries last year. “There were a number of cash flow matters that the EITF issued guidance on and one of those topics was how to classify insurance recoveries,” said Howell. “When you’re recording insurance, you may have an insurance claim that you receive in cash, and that claim could be for a multiple things. It could be related to inventory damage. It could be related to fixed asset recoveries. The EITF clarified that you have to look at the nature of the cash that you’re receiving. If part of that receipt may be related to inventory, that would be an operating activity because the nature of it is related to inventory, and if part of the cash is related to, say, recovery of fixed assets, that would be an investing activity. Companies need to be mindful when they actually start receiving cash from insurance companies, they may receive it in a lump sum. But they have to understand that some of that is related to an operating activity versus an investing activity.”
Multinational companies will also need to look out for some of the income tax reporting implications if they need to repatriate some of the foreign earnings they have been holding abroad, in case they need the funds to help them recover from a natural disaster.
“If a company has indefinitely reinvested their earnings in a foreign jurisdiction, they may not have provided taxes for that,” said Howell. “If you’ve made an assertion that you may have foreign earnings that you’re not going to repatriate, one of the things we highlight in our alert is that if you ever have a cash crunch and you may now need to start consider repatriating earnings that have historically been asserted to be indefinitely reinvested, then that may change their tax treatment such that they may actually have to start providing for income taxes on that.”
Companies will also need to be mindful of their subleases if they are incurring a loss due to a natural disaster. “If you now are not going to be able to collect on that, we walked through situations where you might have a liability for that,” said Howell.
Deloitte’s alert doesn’t discuss in detail the impact of FASB’s new leasing standard because it hasn't yet taken effect. “Most companies haven’t really adopted this yet,” said Howell. “We do say that to the extent that you have a question on that, you need to consult with your independent accounting advisor as to what the impacts could be.”