4.3 Loss Recovery and Gain Contingency Models

In determining whether an asset can be recognized for expected proceeds (e.g., proceeds from an insurance policy), an entity must first consider the amount of the expected proceeds in comparison to the related previously recognized loss, if any. This comparison is illustrated below in the context of the loss recovery and gain contingency models.

Although not codified, paragraph 16 of EITF Issue 01-10 notes that a gain is “a recovery of a loss not yet recognized in the financial statements or an amount recovered in excess of a loss recognized in the financial statements.” Consequently, a loss recovery could be defined as the inverse: recovery proceeds up to the amount of the financial statement loss incurred. The recognition threshold for a loss recovery is that it is probable, as indicated by ASC 410-30-35-8, which states that “an asset relating to the recovery shall be recognized only when realization of the claim for recovery is deemed probable.”

An asset related to a recovery should be recognized for a previously recognized financial statement loss when the recovery is probable. The amount greater than the previously recognized loss or a recovery of a loss not yet recognized in the financial statements should be treated as a gain contingency.

ASC 410-30 addresses the accounting for recovery proceeds related to environmental remediation liabilities. Although that guidance is specific to environmental matters, an entity should apply the recognition and measurement principles in ASC 410-30-35-8 and 35-9 when determining the appropriate recognition of other loss recoveries unrelated to environmental matters.

ASC 410-30

35-8 . . . The amount of an environmental remediation liability should be determined independently from any potential claim for recovery, and an asset relating to the recovery shall be recognized only when realization of the claim for recovery is deemed probable. The term probable is used in this Subtopic with the specific technical meaning in paragraph 450-20-25-1.

35-9 If the claim is the subject of litigation, a rebuttable presumption exists that realization of the claim is not probable.

An entity that incurs a loss attributable to impairment of an asset or incurrence of a liability and expects to recover all or a portion of that loss by filing a claim with an insurance carrier or a claim against other third parties should record an asset for the amount for which the recovery from the claim (not to exceed the amount of the total losses recognized) is considered probable. Amounts greater than an amount for which recovery from the claim was initially considered probable should be subsequently recognized only to the extent that they do not exceed actual additional covered losses or direct, incremental costs incurred to obtain the recovery. Any expected recovery that is greater than covered losses or direct, incremental costs incurred represents a gain contingency; therefore, a higher recognition threshold is required for such a recovery, as described throughout Chapter 3.

Example 4-2

Determining the Probability of a Noninsurance Recovery

Company S discovers that its CFO has perpetrated a fraud by drawing down on a corporate line of credit of $20 million into her personal bank account. Company S’s outside counsel meets with the bank to discuss the fraud and advises S that it will be obligated to repay to the bank the money withdrawn by the CFO. A forensic investigation of the CFO’s personal accounts and holdings uncovers approximately $8 million in assets that could be liquidated (subject to court approval) and applied toward the $20 million obligation.

Company S recognizes a loss of $20 million upon discovery of the CFO’s fraud and receipt of the bank’s communication that S will be responsible for full payment of the $20 million. Although the $8 million is not an insurance policy, the considerations S needs to take into account to determine whether to recognize the $8 million of the CFO’s assets as a recovery asset for the previously incurred $20 million loss are similar to the considerations S would need to take into account to determine whether to recognize insurance proceeds as a recovery asset.

Because S has recognized the full $20 million loss in its financial statements, it should apply the loss recovery model to the $8 million possible recovery and determine whether recovery is probable. If S can conclude that recovery is probable after considering all factors, it may recognize an asset for this expected recovery. If S cannot conclude that recovery is probable, it should not recognize an asset related to recovery unless and until such recovery becomes probable.

A conclusion that a potential recovery is probable may involve significant judgment and should be based on all relevant facts and circumstances. Claim proceeds that will result in a gain should be recognized at the earlier of when the proceeds are realized or realizable. For example, insurance proceeds may be considered realized when the insurance carrier settles the claim and no longer contests payment. Payment alone does not mean that realization has occurred if such payment is made but is being contested or is subject to refund. Recognition of the proceeds may be appropriate after consideration of the conditions outlined in Section 3.3. Further, an entity should analyze proceeds accounted for as a loss recovery by applying the “probable” criterion used to determine a loss contingency (whether an asset has been impaired or a liability has been incurred), as outlined in Section 2.3.1.1.

When recognizing potential loss recoveries from insurance carriers or other third parties, entities should consider both internal and external evidence related to the claim, including:

Direct confirmation from the insurance carrier or other third parties that they would agree with the claim.
In the absence of direct evidence from the insurance carrier or other third parties that they would agree with the claim, an opinion from legal counsel that it is “probable,” as that term is used in ASC 450, that:
- The claim under the policy is enforceable.
- Any loss events are covered.

Before recognizing a potential loss recovery, entities should consider the guidance in ASC 410-30-35-9, which indicates that “[i]f the claim is the subject of litigation, a rebuttable presumption exists that realization of the claim is not probable.”

SEC Considerations

The guidance in ASC 410-30-35-9 is consistent with the SEC staff’s interpretive guidance in Question 2 of SAB Topic 5.Y (codified in ASC 450-20-S99-1). However, additional disclosure requirements are included in footnote 49 of that guidance, which addresses uncertainties regarding the legal sufficiency of claims filed against insurance carriers or other third parties and the solvency of such insurance carriers and other third parties:

The staff believes there is a rebuttable presumption that no asset should be recognized for a claim for recovery from a party that is asserting that it is not liable to indemnify the registrant. Registrants that overcome that presumption should disclose the amount of recorded recoveries that are being contested and discuss the reasons for concluding that the amounts are probable of recovery.

It is likely that in determining whether it is probable that an entity will receive a recovery, the entity will need to understand, among other factors, the solvency of the insurance carrier or other third parties and have sufficient dialogue and historical experience with the insurance carrier or other third parties related to the type of claim in question to assess the likelihood of payment.

Example 4-3

Insurance Recovery of Replacement Cost

A fire destroys Company H’s main operating plant. Immediately after the fire, H recognizes a loss for the net book value of the plant and meets with the insurance adjuster to evaluate the loss and expedite the claim. Given a similar fire loss three years earlier, both parties are familiar with H’s plant and the process by which the adjuster will determine H’s claim settlement amount.

Because H is constructing a similar plant, H and the adjuster are also familiar with the replacement cost of the plant. Accordingly, the adjuster is able to quickly estimate the minimum property damage claim and implement appropriate procedures to process the claim and establish a schedule of reimbursements. The adjuster computes and the insurance carrier approves (settles) a minimum reimbursement for the cost of replacement; the amount is greater than the net book value of the old plant. Company H appropriately recognizes a gain for the excess of the minimum reimbursement over the net book value of the property since the amount was considered realized when the insurance carrier settled the claim and no longer contested the payment to be made to H. The recognition of the excess as a gain is consistent with the guidance in ASC 610-30 on involuntary conversions. It would not be appropriate for H to recognize the excess as a reduction of the cost basis of the replacement plant.

Connecting the Dots

Some incurred losses may be related to past events spanning multiple years or decades, such as losses that arise from asbestos exposure or environmental matters. In these situations, the losses may span periods covered by several insurance carriers, some of which may no longer be solvent, or various policies. Therefore, it may be challenging for an entity to determine whether the incurred loss is a covered event, whether because of vague language used in prior insurance policies or the number of policies or insurance carriers that may have existed at any given time. The entity should consider these potential limitations and factor them into its calculation of the probability that it will receive an insurance recovery for losses spanning multiple years.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.