An entity may experience a loss related to a natural disaster either through the impairment of an asset or the incurrence of a liability. For example, as a result of damage from a natural disaster, an entity may determine that an item of property, plant and equipment is impaired in accordance with IAS 36 Impairment of assets or that a receivable from a customer is impaired in accordance with IFRS 9 Financial instruments (or IAS 39, if still applicable). Alternatively, an entity may incur costs to repair a damaged facility or determine that it has a liability to repair an environmental damage in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Natural disasters – Insurance recoveries and reimbursements
The accounting for insurance claims will differ based on a variety of factors, including the nature of the claim, the amount of proceeds (or anticipated proceeds) and the timing of the loss and corresponding insurance recovery. In addition, any accounting for insurance proceeds will be affected by the evaluation of coverage for that specific type of loss in a given situation, as well as an analysis of the ability of an insurer to satisfy a claim. IAS 37 does not allow the recognition of contingent assets. Accordingly, an insurance recovery asset can only be recognised if it is determined that the entity has a valid insurance policy that includes cover for the incident and a claim will be settled by the insurer. This may be clear from the wording of the insurance policy, but could require confirmation from the insurer that the incident is covered and an appropriate claim will be settled. Natural disasters – Insurance recoveries and reimbursements
The accounting for insurance recoveries is discussed in the following types of categories: Natural disasters – Insurance recoveries and reimbursements
- Property, plant and equipment
- Business interruption
- Other recoveries
Property, plant and equipment
Entities often maintain insurance to mitigate the losses associated with property damage. The accounting for insurance compensation for property, plant and equipment is addressed in both IAS 16 Property, Plant and Equipment and IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Impairment or loss of items of property, plant and equipment and any compensation from third parties (e.g., insurers) are accounted for separately, as follows: Natural disasters – Insurance recoveries and reimbursements
- Impairments of property, plant and equipment are recognised in accordance with IAS 36 Impairment of assets
- Items of property, plant or equipment are derecognised on disposal or when no future economic benefits are expected from the assets’ use or disposal
- Compensation from third parties for property, plant and equipment that is impaired, lost or given up is included in profit or loss when it becomes receivable
Decisions about the recognition and measurement of losses are made independently of those relating to the recognition of any compensation that might be receivable. It is not appropriate to take potential proceeds into account when accounting for the losses. For example, when a building is completely destroyed, the asset must be written off regardless of whether the entity can recover its losses through an insurance policy and intends to repair or replace the facility. When an item of property, plant and equipment is destroyed or damaged in one accounting period, and entitlement to the insurance proceeds cannot be determined until a subsequent period, the loss is recognised when incurred, notwithstanding the potential insurance recovery.
Although IAS 16 does not define the point at which compensation becomes receivable, IAS 37 prohibits the recognition of contingent assets. In such a situation, the recognition of the insurance recovery will only be appropriate when its realisation is virtually certain, in which case the insurance recovery is no longer a contingent asset. ‘Virtually certain’ is not defined in IAS 37 but it is certainly a much higher hurdle than ‘probable’ and, indeed, more challenging than the term ‘significantly more likely than probable’ in the definitions of IFRS 5 Non-current assets held for sale and discontinued operations1. It is reasonable to interpret virtually certain to be as close to 100% as to make any remaining uncertainty insignificant. What this means in practice is that each case must be assessed on its own merits and any judgement should be made in the knowledge that, in any event, it is rarely possible to accurately assess the probability of the outcome of a particular event. However, to the extent that the inflow of economic benefits is probable (the event is more likely than not to occur), IAS 37 requires disclosure of the contingent asset.
In the context of a potential insurance recovery, determining that there is a valid insurance policy for the incident and a claim will be settled by the insurer, may require evidence confirming that the insurer will be covering the claim. The likelihood of receiving compensation should be assessed continually to ensure that developments are appropriately reflected in the financial statements. The asset and the related income are recognised in the period in which it is determined that a compensation will be received. For example, if a previously unlikely receipt becomes probable, but it is still a contingent asset, it will only be disclosed.
This assessment extends to the analysis of information available after the end of the reporting period and before the date of approval of the financial statements. In applying IAS 10 Events after the Reporting Period, an asset is recognised only if the information about the insurance recovery that becomes available in the subsequent period provides evidence of conditions that existed at the end of the reporting period and its realisation was virtually certain at that time.
Natural disasters – Recognition of an insurance recovery Natural disasters – Insurance recoveries and reimbursements
Assume Entity A, with a 31 March 2017 year-end, owned property with a net book value of CU100 just before a natural disaster that completely destroys the property in March 2017. The fair value of the property was CU130 based on an independent appraisal shortly before the natural disaster. Also assume that Entity A’s insurance policy provides for compensation for any insured loss based on the fair value of the property.
Entity A would recognise a CU100 loss on the property in the period the natural disaster occurred. A CU130 insurance recovery for the incurred loss would be recognised in the period it is determined that there is no contingency that the insurance entity will settle the claim. If settlement was only probable, the claim would be disclosed, but not recognised.
The illustration below considers that there is uncertainty in the settlement of the claim and has been simplified in that it assumes the complete destruction of the insured asset. These concepts would also apply to a recognised partial impairment of the insured asset. Natural disasters – Insurance recoveries and reimbursements
Impact on financial statements as at 31 March 2017
Threshold met at 31 March 2017
Threshold only met after 31 March 2017 but before the financial statements are approved
Claim is virtually certain
Recognise an asset of CU130 and a gain of CU 30
Disclose the claim
Claim probable, but not virtually certain
Disclose the claim
Disclose the claim
Claim not probable
Similar considerations apply to the recognition of a receivable for the compensation of repair and maintenance work under an insurance policy, even when an impairment or write-off of the insured asset is not required and regardless of whether compensation is greater than, equal to, or less than, the costs incurred. For example, if an entity believes it is entitled to a CU1,500 insurance compensation as a result of damage to an asset that is not impaired, but for which the entity has incurred repair costs of CU1,000 at the year-end, the CU1,500 compensation will only be recognised once the entity determines that the insurance policy includes this damage and a claim will be settled by the insurer. Natural disasters – Insurance recoveries and reimbursements
In the case of a natural disaster, it is often unclear which events and costs are covered by insurance policies and significant uncertainty will exist as to whether or not any compensation will be available. Until such uncertainties are adequately resolved, it would not be appropriate to recognise an asset. In many situations, direct confirmation from the insurer may be the most reliable source of evidence that the entity is covered and that a claim will be accepted.
An entity’s business interruption policies require a careful analysis of the terms and conditions due to the wide variety of terms relating to the nature and level of losses covered. Many policies cover temporary relocation costs (e.g., duplicate rent) that may be easily quantified after the loss event. Others cover lost revenue or operating margins that typically are measured over a longer term require comparisons with similar periods in prior years. In such cases, no compensation would be available if revenue or operating margins recover during the measurement period. For example, a claim under a policy with a quarterly measurement period would not be valid if a retailer were to lose an entire month’s revenue, but recover that revenue before the end of the quarter.
Similar to the treatment of compensation from property, plant and equipment, insurance recoveries for business interruption are not recognised if they represent contingent assets.
Natural disasters can often result in additional obligations, for example, obligations to repair environmental damage. When the cost of meeting those obligations is covered by insurance, the related reimbursements would be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Decisions about the recognition of a provision are made independently of those relating to the recognition of any related reimbursement. An obligation is recognised as soon as settlement becomes probable, whereas a receivable is recognised only when settlement of the insurance claim is virtually certain. Accordingly, the receivable may be recognised at a later date than the provision for the related obligation. IAS 37 also limits the amount that may be recognised for a reimbursement of expenditure required to settle a provision to the amount of the provision recognised.
Natural disasters – Recognition of an insurance reimbursement
Assume that after a natural disaster, Entity A recognises a CU1 million provision for its obligation for environmental rehabilitation, which it will undertake itself. Entity A’s insurance policy covers the cost of hiring an external contractor to perform the environmental rehabilitation. Before the end of the reporting period, the insurer has confirmed it will pay Entity A up to CU1.5 million as the environmental rehabilitation is performed. Natural disasters – Insurance recoveries and reimbursements
Entity A would recognise a CU1 million provision for environmental rehabilitation costs and a corresponding virtually certain insurance reimbursement asset that is limited to CU1m. Any increase in the estimate of the rehabilitation costs to be incurred up to CU1.5 million would result in a corresponding increase in the amount recognised for the reimbursement asset.
Presentation of insurance proceeds
‘Netting off’ is not allowed in the statement of financial position, with any insurance reimbursement asset classified separately from any provision. However, the expense relating to a provision can be shown in the profit or loss net of any corresponding reimbursement. Natural disasters – Insurance recoveries and reimbursements
IAS 7 Statement of Cash Flows requires cash flows related to property, plant and equipment to be classified in cash flows from investing activities. Cash flows from operating activities are described as cash flows from the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Insurance proceeds used for fixed asset expenditures that qualify for recognition in property, plant and equipment are classified as cash flows from investing activities. Insurance proceeds used for items that are not property, plant and equipment (i.e., repairs and maintenance) are classified as operating activities. Natural disasters – Insurance recoveries and reimbursements