4.6 Business Interruption Insurance

ASC 220-30-20 defines business interruption insurance as “[i]nsurance that provides coverage if business operations are suspended due to the loss of use of property and equipment resulting from a covered cause of loss. Business interruption insurance coverage generally provides for reimbursement of certain costs and losses incurred during the reasonable period required to rebuild, repair, or replace the damaged property.” ASC 220-30-05-02 describes the types of costs and losses that business interruption insurance covers.

The guidance in Section 4.3 on loss recoveries and gain contingencies applies to the accounting for business interruption insurance. That is, certain fixed costs incurred during the interruption period may be analogous to losses from property damage; accordingly, it may be appropriate to recognize a receivable (not to exceed the amount of costs incurred) for amounts whose recovery is considered probable. A recovery receivable should be recognized into income when the direct and incremental losses are incurred if the entity concludes that receipt of the recovery proceeds is probable. A recovery receivable should be recognized only up to the amount of the financial statement loss incurred (e.g., the fixed costs incurred). The possible recovery of lost profit margin should be considered a gain contingency since the absence of expected profit margin would not be considered a previously recognized financial statement loss. Therefore, the recovery of lost profit margin should be recognized in income when the gain contingency is resolved (i.e., the proceeds are realized or realizable). Because of the usually complex and uncertain nature of the settlement negotiations process, recognition of the lost profit margin (i.e., the gain contingency) may occur at the time of final settlement or when nonrefundable cash advances are made.

Because business interruption insurance may be paid in a lump-sum amount to the insured, including reimbursement for both property damage and lost profit margin, it may be difficult to determine whether the recovery is for losses previously recognized in the financial statements (i.e., whether the recovery should be considered a determinable mix or an indeterminable mix of loss recovery and gain contingency). We encourage entities to consult with their accounting advisers when evaluating whether a receivable may be recognized for expected insurance recoveries associated with fixed costs incurred during the interruption period.

 

Connecting the Dots

There may be situations in which business interruption insurance is paid as an advance, lump-sum, nonrefundable final settlement amount for both future estimated fixed costs (e.g., continued labor, utilities) and estimated future lost profit margin for a claim period that covers future reporting periods. Under these circumstances, the amount received in advance related to future estimated fixed costs or future estimated lost profit margin is treated as a gain contingency. Therefore, because the advance payment is final and nonrefundable, the gain is considered realized even though the future fixed costs or lost profit margin has not yet occurred. There is no remaining contingency; the gain is therefore recognized in the financial statements given that there is no basis for deferring and amortizing the insurance proceeds over the future anticipated periods of continuing fixed costs or lost profit margin.

ASC 220-30-45-1 addresses the income statement presentation related to business interruption insurance and allows an entity to “choose how to classify business interruption insurance recoveries in the statement of operations, as long as that classification is not contrary to existing generally accepted accounting principles (GAAP).” In addition, in a period in which business interruption insurance recoveries are recognized, ASC 220-30-50-1 requires further disclosures in the notes to financial statements.