A Global Reach with a Local Perspective University of North Alabama 19th Annual Decosimo Accounting Forum July 22, 2011 www.decosimo.comFINANCIAL REPORTING FOR NATURALDISASTERSJENNIFER GOODMAN, CPAAssurance Principal
Accounting issues associated with anatural disaster How should losses be classified in the statement of operations? When should an asset impairment loss be recognized? When should a liability for non-impairment losses and costs be recognized? What is the accounting for insurance recoveries to cover losses sustained? What are the additional considerations related to business interruption insurance recoveries? What are the required disclosures?
Classification of losses Extraordinary Items must be both: Unusual in Nature – possess a high degree of abnormality (does not mean the event is beyond the control of management) AND Occur Infrequently - not reasonably expected to recur in the foreseeable future taking into account the environment in which the entity operates
Stringent rules extraordinary classificationThe requirements to be extraordinary are very stringent. The SEC generally will not allow extraordinary treatment for: Settlement of litigation – in general litigation is a normal cost of business Write-off of goodwill Natural disasters – if the region has a history of such disasters
Stringent rules extraordinary classificationThe severity of a natural catastrophe ordinarily would not impact the determination of whether an item is extraordinary if similar events with less severity occur with relative frequency.SEC staff commented at the AICPA Twentieth National Conference that losses from Hurricane Andrew did not meet the unusual criteria. Additionally, due to the locality of the devastated businesses, the infrequency of occurrence of severe windstorms was not met either. Some registrants were totally wiped out by the hurricane.
Is it an extraordinary item? A large portion of tobacco farmer crops are destroyed by hail storm. Severe damage from hair storms in the locality where the farmer grows tobacco are rare. A citrus growers Florida crop is severely damaged by frost. The farmer is likely to lose 75% of his total crop. Frost damage is normally experienced every three or four years.
Is it an extraordinary item? A large portion of tobacco farmer crops are destroyed by hail storm. YES – both infrequent in occurrence and unusual A citrus growers Florida crop is severely damaged by frost. NO - Not infrequent in occurrence taking into account the environment in which the entity operates
Is it an extraordinary item? A steel fabricating entity sells the only land it owns. The land was acquired 10 years ago for expansion but shortly thereafter the entity abandoned all plans and held the land for appreciation. An entity that operates a chain of warehouses sells excess land surrounding one of its warehouses. When the entity buys property to establish a new warehouse, it buys more land than it expects to use for the warehouse expecting that the land will appreciate in value. In the past 5 years, there have been two instances where the entity sold such excess land.
Is it an extraordinary item? A steel fabricating entity sells the only land it owns. YES – Infrequent of occurrence because not past history of event and unusual for a steel fabricator to hold land for appreciation i.e. not their line of business AND they never used in the business An entity that operates a chain of warehouses sells excess land surrounding one of its warehouses. NO - criterion of infrequency of occurrence has not been met; past experience indicates sales may reasonably be expected to recur in the foreseeable future
Is it an extraordinary item? A fire destroys 30% of a manufacturing plant. This was the first fire effecting the company in its 15 years of existence. The Company had to ship products off to be painted for the next 6 months while the finishing and painting area was rebuilt. A textile manufacturer with only one plant moves to another location. It has not relocated a plant in 20 years and has no plans to do so in the foreseeable future. How should moving cost and losses be treated?
Is it an extraordinary item? A fire destroys 30% of a manufacturing plant. NO - reasonably expected to recur in the foreseeable future considering the environment in which an entity operates i.e. manufacture/industrial plant with combustion supplies A textile manufacturer with only one plant moves to another location. NO - moving to another location is an occurrence which is a consequence of customary and continuing business activities, some of which are finding more favorable labor markets, more modern facilities, and proximity to customers or suppliers
Asset Impairments – held and used Impairment loss is recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount is not recoverable if it exceeds the sum of undiscounted cash flows expected to result from the use and eventual disposition of the asset. A long-lived asset shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Example: A significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition.
Asset impairments – to be abandonedLong-Lived Assets to Be Abandoned: A long-lived asset to be abandoned is disposed of when it ceases to be used. If an entity commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, depreciation estimates shall be revised to reflect the use of the asset over its shortened useful life. When a long-lived asset ceases to be used, the carrying amount of the asset should equal its salvage value, if any. A long-lived asset that has been temporarily idled shall not be accounted for as if abandoned.
Asset Impairments – idle property In general, idle property should continue to be depreciated and assets should be segregated on the balance sheet or footnotes. When idleness is other than temporary, this may require a write-down to fair value less cost to sale on the date management decides the item will no longer be used. Under these circumstances the items should no longer be depreciated. When the period of idleness is other than temporary, the assets should be transferred to Other Assets in the period the determination is made.
Liability for cost related to a natural disaster FASB ASC 450-20-25-2 requires a loss accrual by a charge to income, if it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and the amount of loss can be reasonably estimated.
Liability for cost related to a natural disasterParagraph 63 of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, states liabilities should be recognized when: a. the item meets the definition of a liability (probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events) b. the liability can be measured with sufficient reliability. c. the information about the liability is capable of making a difference in user decisions. d. the information about the liability is representationally faithful, verifiable, and neutral.
Accounting for insurance recoveriesFASB ASC 605-40 clarifies the accounting for involuntary conversions of nonmonetary assets (property or equipment) to monetary assets (insurance proceeds). Not equivalent to an exchange transaction Recognize gain or loss to the extent the cost of a nonmonetary asset differs from the amount of monetary assets received Doesn’t matter if the entity is obligated to reinvest the monetary assets in replacement nonmonetary assets Cost of subsequently acquired nonmonetary assets is recorded for consideration paid and not affected by a previous transaction
Accounting for insurance recoveriesIf a nonmonetary asset is destroyed or damaged in one accounting period, and the amount of monetary assets to be received is not determinable until a subsequent accounting period, gain or loss shall be recognized as discussed in chapter 450 Contingencies.
Accounting for insurance recoveries Treatment is slightly different for recovery gain contingencies verses “normal” gain contingencies Recovery of a recorded contingent loss shall be recognized when realization of the recovery is deemed probable (i.e., likely to happen). Recovery of an amount in excess of the related recorded contingent loss shall be recognized only when all contingencies relating to recovery have been resolved
Presentation of insurance recoveries Disclose: A description of the nature and amount of recoveries recognized. A description of recoveries that have not yet been recognized in the financial statements but that are reasonably expected to impact the entity’s financial statements in the near term. Consider disclosing: The estimated time frame for realization of recognized probable recoveries, if realization is not expected in the near term.
Presentation of extraordinary itemsExtraordinary items shall be segregated from the results of ordinary operations and shown separately in the income statement with disclosure of the nature and amounts: Income before extraordinary items $ XXX Extraordinary items (less income tax of $ ___) XXX Net income $ XXXThe nature of an extraordinary event or transaction and the principal items entering into the determination of an extraordinary gain or loss shall be described.
Presentation of unusual or infrequent itemsReport as a separate component of income from continuing operations. The nature and financial effects of each event shall be disclosed on the face of the income statement or, alternatively, in notes to financial statements.Items shall not be reported on the face of the income statement net of income taxes or in any other manner that may imply that they are extraordinary items.
Additional consideration for businessinterruption An entity may choose how to classify business interruption insurance recoveries in the statement of operations, as long as that classification is not contrary to existing GAAP. The following shall be disclosed in the footnotes in the period business interruption insurance recoveries are recognized: Nature of the event resulting in business interruption losses, and Aggregate amount of business interruption insurance recoveries recognized during the period and the line item(s) in the statement of operations in which those recoveries are classified.
Entity’s evidence is destroyed Third standard of field work states: “The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.” If substantially all of an entity’s evidence in support of their financial statements has been destroyed and the auditor has been unable to complete audit procedures, the auditor should disclaim an opinion on the financial statements as the auditor is unable to form an opinion as to the fairness of presentation of the financial statements. Independent auditor’s report example on next slide.
We were engaged to audit the accompanying balance sheets of X Company as of December 31, 20X2 and 20X1, and the related statements of income, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management.Substantially all of the Company’s books of original entry; the general and subsidiary ledgers; related accounting manuals; records such as work sheets and spreadsheets supporting cost allocations, computations, and reconciliations; as well as substantially all corroborating evidence in support of the financial statements were destroyed by _____ which also destroyed the Company’s headquarters. The records that remain are not sufficient to permit the application of auditing procedures that would be adequate for us to express an opinion on the accompanying financial statements.Since the Company was not able to provide evidence or corroborating evidence in support of the accompanying financial statements and we were not able to apply other auditing procedures to satisfy ourselves as to whether the financial statements are presented in accordance with generally accepted accounting principles, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on the financial statements.
Audit documentation is destroyed Choices: 1) recreate the audit documentation 2) re- perform the audit procedures and create new audit documentation. Audit documentation should be sufficient to (a) enable members of the engagement team with supervision and review responsibilities to understand the nature, timing, extent, and results of procedures performed, and the evidence obtained; (b) indicate the team member who performed and reviewed the work; and (c) show that the accounting records agree or reconcile with the financial statements. Auditor will usually have to re-perform the audit procedures and create new audit documentation.
Event occurs after year-end Type II subsequent event; no adjustment to the financial statements Consider disclosure to keep financial statements from being misleading Extremely significant, consider pro forma balance sheet Material impact on entity, consider emphasis of matter paragraph Does event cause substantial doubt about ability to continue as a going concern?
Accounting literature FASB Accounting Standards Codification 225, Income Statement, 20 Extraordinary and Unusual Items AICPA Technical Questions and Answers, Section 5400: Extraordinary and Unusual Items AICPA Technical Questions and Answers, Section 8345: Audit Evidence - Destruction of Documents AICPA Technical Questions and Answers, Section 9070: Subsequent Events
Connect with me Jennifer Goodman, CPA Assurance Principal 423.756.7100 firstname.lastname@example.org On LinkedIn: http://www.linkedin.com/pub/jennife r-goodman/25/7b1/49a Disclaimer: The contents of this presentation are for informational purposes only. The information is not intended to be a substitute for professional accounting counsel. Always seek the advice of your accountant or other financial planner with any questions you may have regarding your financial goals or specific situations.