Authored by David Johnson
In the wake of recent natural disasters such as hurricanes Harvey, Irma and Maria and the earthquake near Mexico City, it is important for companies to understand potential U.S. GAAP accounting implications. Even companies not directly impacted by these or other natural disasters may need to consider the potential accounting and / or disclosure implications of such events on their financial statements. Potential impacts range from impairment to insurance to going concern.
Following a natural disaster companies need to evaluate their assets for potential impairment. The ordering of impairment tests can affect their results, therefore, it is important to perform them in the proper order. The proper order is as follows:
- other assets (e.g., inventories, accounts receivable, etc.),
- indefinite-lived intangible assets (other than goodwill)
- long-lived assets (as an asset group), and
If impaired, the assets’ carrying values would be adjusted prior to the performance of the next impairment test. Assuming that this impairment evaluation is not part of the company’s required annual impairment tests, the company would begin their indefinite intangible asset, long-lived asset and goodwill impairment tests by determining whether events and circumstances related to the natural disaster indicate that the company’s assets may be impaired. If the events and circumstances indicate possible impairment, the company would complete the remainder of the impairment tests.
Companies should keep in mind that even if they are not located in an area affected by a natural disaster, events and circumstances related to a natural disaster could indicate that their assets may be impaired. For example, this could be the case for companies with significant customers or suppliers, collateralized loans or insurance liabilities of policy holders in an affected area.
Companies, especially those located in areas at higher risk for natural disasters, typically maintain insurance to protect themselves against financial losses caused by natural disasters. Certain factors, such as the amount and timing of insurance proceeds can complicate the related accounting. U.S. GAAP requires the losses caused by natural disasters and related insurance recoveries be accounted for separately. Insurance proceeds up to the amount of losses recognized are considered recoveries and are recorded when receipt is considered probable (i.e., likely to occur).
If a natural disaster occurs in one reporting period, but the receipt of the related insurance recovery is not considered probable until after the financial statements are issued / available to be issued, the loss and related recovery would be recorded in different periods. In this situation, including appropriate disclosures in the financial statements regarding potential insurance recoveries would be particularly important. Insurance proceeds received in excess of losses recognized are considered gain contingencies and would not be recorded until all contingencies have been resolved (e.g., after the insurance company has confirmed coverage and the amount of the excess insurance proceeds to be received has been determined).
The occurrence of natural disasters can result in environmental related liabilities (e.g., oil or gas spills, chemical leaks, etc.). Environmental liabilities should be recorded when it is probable a liability has been incurred and the amount of the loss can be reasonably estimated. The liability recorded should include incremental direct remediation costs and compensation and benefit costs of employees expected to devote a significant amount of time directly to the remediation effort.
Determining the amount of environmental liabilities is typically an ongoing process and companies should accrue for costs as they become estimable even though the total liability may not be known at that time. For example, a company may be able to estimate the cost of a scheduled environmental remediation investigation and feasibility study, but unable to estimate the total cost of the remediation effort until after the study has been completed. In this example, the company would accrue for the cost of the study and disclose the fact that additional remediation costs are likely to be incurred, but that those costs cannot be estimated at this time. If the entire environmental liability cannot be reasonably estimated, the company would disclose the nature of the liability and the fact that the liability cannot be estimated. Determining the proper accounting for environmental liabilities can be complex, therefore, companies should refer to the guidance in Financial Accounting Standards Board Accounting Standards Codification 410-30 Environmental Obligations when making this determination.
Risks and uncertainties
Current vulnerability due to certain concentrations
Certain concentrations such as facilities, customers or suppliers located in areas affected by a natural disaster may require additional financial statement disclosure to inform financial statement users about the risks to the company created by those concentrations. Additional disclosure is required if, before the financial statements are issued / available to be issued, all of the following criteria are met:
- the concentration existed at the date of the financial statements;
- the concentration makes the entity vulnerable to the risk of a near-term (i.e., within one year from the date of the financial statements) severe impact (i.e., a significant financially disruptive effect on the normal functioning of the company); and
- it is at least reasonably possible (i.e., more than remote) that the events that could cause the severe impact will occur in the near term.
If these criteria are met, companies should disclose information in their financial statements that is adequate to inform users about the general nature of the risks associated with these concentrations.
Estimates made in the wake of a natural disaster made be subject to material changes in the near term as more information becomes available to the company (e.g., estimates related to impairments, insurance recoveries, environmental liabilities, etc.). When both of the following criteria are met, the related estimates require additional disclosure:
- it is at least reasonably possible that the estimate will change in the near term due to one or more future confirming events and
- the effect of the change would be material to the financial statements.
The required additional disclosure should include the nature of the uncertainty and an indication it is at least reasonably possible a change in the estimate will occur in the near term.
Natural disasters will likely impact, potentially significantly, companies’ required going concern evaluations and related disclosures. This potential impact could include companies not located in the affected area, for example, through the effect of the natural disaster on the companies’ significant customers or suppliers. Companies should be aware that if a natural disaster occurs after a company has completed their required going concern evaluations, but before the financial statements are issued / available to be issued, they will likely need to update their evaluations to include the effects of the natural disaster.
Unusual or infrequently occurring items
The nature and financial effects of natural disasters that are considered unusual in nature (i.e., possess a high degree of abnormality) or occur infrequently (i.e., not reasonably expected to recur in the foreseeable future), [APB 30, paragraph 26, sequence n/a]][or both, are required to be presented as a separate component of income from continuing operations or disclosed in the notes to the financial statements. In determining both the unusual and infrequent nature of natural disasters, companies need to take into account the environment in which they operate.
Natural disasters may occur subsequent to the date of a company’s financial statements, but prior to the date that the financial statements are issued / available to be issued. If companies are impacted, directly or indirectly, by a natural disaster after the date of their financial statements, companies should determine whether disclosing the effects of the natural disaster are necessary in order to keep their financial statements from being misleading. If disclosure is considered necessary, the disclosure should include the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made.
Considerations for SEC registrants
In addition to the general considerations above, SEC registrants may have current reporting obligations under Form 8-K and should also include the effects of natural disasters in their management's discussion and analysis of financial condition and results of operations (MD&A). Registrants should also consider revising risk factor disclosures in light of the effects of the natural disaster on financial results or operations.
Considering the potential accounting and / or disclosure implications after a natural disaster can be complex and burdensome, especially considering management’s many other responsibilities following a crises such as this, but it is a necessary part of the recovery process and for providing financial statement users with the information necessary to make informed decisions about the entity’s future.
For more information on this topic, or to learn how Baker Tilly accounting specialists can help you, contact our team.