Chapter 4 — Loss Recoveries
Chapter 4 — Loss Recoveries
4.1 Overview
Chapters 3 and 4 of this Roadmap address the accounting for loss
and gain contingencies. This chapter addresses the accounting for recoveries
pertaining to a previously recognized financial statement loss (e.g., an impairment
of an asset or incurrence of a liability), as well as recoveries from business
interruption insurance. Insured losses might result from partial or full destruction
of an entity’s property or equipment because of fire, earthquake, hurricane, or
other natural disasters, as well as losses that arise from asbestos exposure or
environmental matters. Insured losses can also take the form of insured director and
officer costs and result from fraudulent activities undertaken by employees. Loss
recoveries may be received from litigation settlements, insurance proceeds, or
reimbursement of an employee’s fraudulent activities through liquidation of the
employee’s assets.
An entity should consider four accounting models when determining
the recognition and measurement of expected insurance or other proceeds related to a
recovery: (1) the loss recovery model, (2) the gain contingency model, (3) a
determinable mix of the loss recovery and gain contingency models, and (4) an
indeterminable mix of the loss recovery and gain contingency models.
Loss recovery model
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An asset for which realization is probable
should be recognized only up to the amount of the previously
recognized loss. The analysis of whether recovery is
probable is consistent with the guidance on loss contingency
recognition in Chapter 2. See
Section 4.3 for additional information.
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Gain contingency model
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Recovery proceeds related to a loss that has
not been recognized in the financial statements should be
accounted for as a gain contingency as described in
Chapter 3. See Section 4.3 for
additional information.
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Determinable mix of loss recovery and gain
contingency models
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A combination of the loss recovery and gain
contingency models is applied when recovery proceeds are
expected to exceed the amount of the previously recognized
loss. The probable recovery proceeds equal to the amount of
the recognized loss should be accounted for by using the
loss recovery model. The expected proceeds in excess of the
recognized loss should be accounted for by using the gain
contingency model. For an entity to apply the determinable
mix model, there must be a direct linkage between the
recovery proceeds and the specifically identifiable
recognized loss. See Section 4.4 for
additional information.
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Indeterminable mix of loss recovery and gain
contingency models
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An indeterminable mix of the loss recovery
and gain contingency models results from a situation in
which there is no clear evidence that the amount of the
recovery proceeds is a recovery of previously recognized
losses or costs (i.e., there is no direct linkage) or the
amount of the loss or costs previously incurred is not
objectively quantifiable (i.e., the losses or costs are not
specific, incremental, identifiable costs or losses). Under
these circumstances, the application of the gain contingency
model would be appropriate for the entire amount of the
recovery proceeds. See Section 4.4 for
additional information.
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These four models are based on the loss contingency model and the
gain contingency model, both of which are codified in ASC 450. In addition, the
accounting for recovery proceeds builds upon ASC 450, drawing from other parts of
U.S. GAAP, including guidance on involuntary conversions (ASC 610-30); how to
account for the impact of the September 11, 2001, terrorist attacks (EITF Issue
01-10); and environmental obligations (ASC 410-30). This chapter describes how these
additional sources of U.S. GAAP form the basis for the accounting for recovery
proceeds.
4.2 Involuntary Conversions
Insurance is often maintained to mitigate losses in the event of
property damage or casualty losses. The recognized loss and the associated recovery
proceeds (through insurance proceeds or other sources of recovery) are treated as
two separate events and therefore two separate units of account. The principle
underlying this separation, which is the basis for the accounting models described
in Sections 4.3 and
4.4, is derived
from the involuntary conversion guidance codified in ASC 610-30.
ASC 610-30
25-2 An
involuntary conversion of a nonmonetary asset to monetary
assets and the subsequent reinvestment of the monetary
assets is not equivalent to an exchange transaction between
an entity and another entity. The conversion of a
nonmonetary asset to monetary assets is a monetary
transaction, whether the conversion is voluntary or
involuntary, and such a conversion differs from exchange
transactions that involve only nonmonetary assets. To the
extent the cost of a nonmonetary asset differs from the
amount of monetary assets received, the transaction results
in the realization of a gain or loss that shall be
recognized.
25-3
Involuntary conversions of nonmonetary assets to monetary
assets are monetary transactions for which gain or loss
shall be recognized even though an entity reinvests or is
obligated to reinvest the monetary assets in replacement
nonmonetary assets. However, the requirement of this
Subtopic with respect to gain recognition does not apply to
an involuntary conversion of a last-in, first-out (LIFO)
inventory for which replacement is intended but not made by
year-end and the taxpayer does not recognize gain for income
tax reporting purposes. Paragraph 270-10-45-6(b) provides an
exception for the liquidation of a LIFO inventory at an
interim date if replacement is expected by year-end.
Accordingly, that exception applies to an involuntary
conversion of a LIFO inventory if replacement is expected by
year-end.
25-4 In some
cases, a nonmonetary asset may be destroyed or damaged in
one accounting period, and the amount of monetary assets to
be received is not determinable until a subsequent
accounting period. In those cases, gain or loss shall be
recognized in accordance with Topic 450.
When a nonmonetary asset (e.g., property) is involuntarily converted
to a monetary asset (e.g., an insurance receivable), an entity must recognize the
effects of the monetary transaction even if the proceeds are reinvested (voluntarily
or by requirement) in the replacement or repair of the nonmonetary asset. The loss
of a nonmonetary asset and subsequent monetary recovery through insurance are
therefore accounted for as two separate units of account.
Example 4-1
Involuntary
Conversion
A fire destroys Company X’s operating plant.
Company X must write off the plant, recognizing a loss,
regardless of its decision or the insurance company’s
requirements to use the proceeds to replace or repair the
plant. Any insurance proceeds received are accounted for
separately and apart from the incurred loss.
If the property or equipment is destroyed or
damaged in one period and the recovery proceeds are not
determinable until a subsequent period, X recognizes the
loss when incurred without considering possible recognition
of a monetary recovery (e.g., cash proceeds).
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.
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.
4.4 Determinable and Indeterminable Mix of Loss Recovery and Gain Contingency Models
Under the determinable mix model, the probable recovery proceeds
equal to the amount of the recognized loss should be accounted for by using the loss
recovery model. Any expected proceeds in excess of the recognized loss should be
accounted for as a gain contingency. When there is no clear evidence that the amount
of the proceeds is a recovery of previously recognized losses or incremental costs
(i.e., there is no direct linkage) or the amount of the loss or costs previously
incurred is not objectively quantifiable (i.e., specifically identifiable), the gain
contingency model would be applied to the entire amount of the recovery proceeds
(also referred to as the indeterminable mix model). The determinable mix model,
which encompasses both the loss recovery model and the gain contingency model, and
the indeterminable mix model, which results in the application of the gain
contingency model to probable recovery proceeds, are further illustrated below.
Application of the gain contingency model for the entire amount of
the probable proceeds is illustrated below.
The example below illustrates the application of the indeterminable
mix model, while Example
4-5 illustrates the application of the determinable mix model.
Example 4-4
Indeterminable Mix of
Loss Recovery and Gain Contingency Models
Company T joins a class action lawsuit
against Credit Card Company Y because Y has overcharged for
various credit card transactions over the past 10 years.
Credit Card Company Y and T enter into a settlement
agreement, subject to the final approval of the claims
administrator, for an estimated amount of $35 million
payable to T over the next 5 years. Company T concludes that
it is probable that it will receive at least $35 million
from the settlement. The settlement agreement includes the
recovery of actual and estimated overcharges, punitive
damages, payment to avoid further cost of litigation, and
payment to restore a collaborative business
relationship.
The recovery of the overcharges amount is
based on actual and estimated overcharges over the past 10
years. Company T is unable to determine a direct linkage
between (1) what represents cost recovery of the previously
recognized overcharges and (2) punitive damages. Further, Y
contends in all legal proceedings that the lawsuit is
without merit and that T has not previously incurred any
losses. From Y’s perspective, it is settling the lawsuit to
restore a collaborative business relationship rather than to
repay T’s incurred losses. Accordingly, the amount of the
loss previously incurred is not objectively
quantifiable.
For T to characterize an amount as a loss
recovery, the amount should represent the reimbursement of
specific, incremental, identifiable costs that were
previously incurred. Company T determines that it is unable
to objectively determine how much of the settlement
represents recovery of previously recognized overcharges.
Therefore, T applies the gain contingency model to the
entire amount of the settlement. Uncertainties remain
regarding the settlement’s approval; therefore, T should
defer recognition of the gain until sufficient information
is available for T to conclude that the gain is realized or
realizable.
4.5 Insurance Deductible
Before recognizing an asset for expected insurance proceeds, an
entity should consider the individual policy covering the loss and analyze whether
the asset should be reduced for any policy-related deductibles.
Example 4-5
Insurance Recovery of
Fair Market Value With Deductible
An earthquake destroys Company R’s corporate
headquarters. At the time of the earthquake, the net book
value of the corporate headquarters is $350,000. Company R’s
insurance policy covers the fair market value of the
property, and R has a $50,000 deductible. In accordance with
the insurance policy, the fair market value of the corporate
headquarters is based on a third-party appraisal before the
earthquake. Company R carefully analyzes the provisions of
the insurance policy regarding the deductible. Using an
external expert, R determines that the fair value of the
corporate headquarters before the earthquake was $500,000.
In the same period as the earthquake, the
insurance adjuster communicates to R that once the fair
value is determined, an amount equal to the fair market
value of the property, reduced by the deductible, will be
paid to R, and the amount will not be subject to refund.
Because this is a determinable mix of a loss recovery and a
gain contingency, in the current period in which the
earthquake occurs, R recognizes a loss of $350,000 for the
net book value of the destroyed corporate headquarters and a
corresponding insurance recovery receivable of $350,000. The
loss recovery receivable is recognized because R concludes
that it is probable that the insurance recovery will be
realized.
Because it is probable that the insurance
recovery will be realized and the fair value of the facility
was determined to be well above the net book value of the
corporate headquarters, it would be appropriate for R to
recognize the entire $350,000 loss recovery in the period in
which the loss on the property is recognized. In a scenario
in which there is sufficient evidence that the insurance
payment (in this case, $450,000, which represents the
$500,000 fair market value of the property reduced by the
$50,000 deductible) will exceed the amount of recognized
loss (in this case, $350,000), it would be appropriate for R
to recognize an insurance recovery receivable in an amount
of $350,000 and apply the deductible to the deferred gain,
which represents the excess amount of the fair market value
over the net book value of the property.
The deferred gain is the $100,000 difference
between the expected insurance proceeds of $450,000 less the
$350,000 recognized recovery receivable. Such a gain
contingency should not be recognized until all contingencies
are resolved and the insurance proceeds are realized. In
this example, R may conclude that the $100,000 is realized
once the adjuster pays or confirms the related covered
amount (the fair value of the corporate headquarters) and
the amount is no longer contested or subject to refund (see
Chapter 3 for additional considerations
related to the determination of the appropriate period in
which to recognize the gain contingency).
Evidence to Support
Probable Receipt of $350,000 Insurance Proceeds
To recognize the $350,000 recovery
receivable, R considered whether it had sufficient evidence
to support recognition of the full amount of the loss
recovery receivable. If, for example, the external expert
had determined the fair value of the corporate headquarters
to be $400,000 rather than $500,000, it may have been more
difficult for R to conclude that the full $350,000 loss
recovery asset would have been received because there would
have been no excess (i.e., cushion) of fair value over the
net book value of the property. In these situations, an
entity could consider consulting with its accounting
advisers.
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 damaged property.” ASC 220-30-05-02 describes the types of costs
and losses that business interruption insurance covers.
ASC 220-30
05-2 The types
of costs and losses covered by business interruption
insurance typically include the following:
- Gross margin that was lost or not earned due to the suspension of normal operations
- A portion of fixed charges and expenses in relation to that lost gross margin
- Other expenses incurred to reduce the loss from business interruption (for example, rent of temporary facilities and equipment, use of subcontractors, and so forth).
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 independent accountants
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.
Example 4-6
Recognition of Business
Interruption Insurance Proceeds
On January 7, 20X1, a fire severely damages
Company W’s retail store, resulting in impaired operations
and lost profits. Company W maintains insurance coverage to
cover business interruption losses, including both fixed
costs incurred and profits lost during the inoperable
period. The insurance policy coverage period is from January
1, 20X1, to December 31, 20X1. Company W expects that the
retail store will be closed until at least the second
quarter of 20X2.
Company W’s insurance policy covers $100,000
of continued fixed costs and lost profits during the
inoperable period, but the policy does not bifurcate the
$100,000 between the two categories. In addition, W
estimates that for the remainder of 20X1, its continued
fixed costs will be $100,000 and its lost profits will be
$150,000.
During the period from January 7, 20X1, to
April 30, 20X1, the date W issues its first-quarter
financial statements, W and its insurer have ongoing
discussions regarding the accuracy of W’s estimates of
continuing fixed costs and lost profits expected through
December 31, 20X1. Company W believes that as of April 30,
20X1, it is probable that it will receive insurance proceeds
of the full $100,000 policy; however, the insurer has not
distinguished what portion of the probable $100,000 payment
should be allocated to the expected continuing fixed costs
(which includes certain fixed costs incurred and recognized
in the first-quarter financial statements) or to the
estimated lost profits in the period from January 7, 20X1,
to December 31, 20X1.
In its first-quarter financial statements, W
concludes that the entire probable insurance payment can be
attributed to an indeterminable mix of (1) previously
recognized fixed costs recognized during the first quarter,
(2) estimated future fixed costs to be incurred, and (3)
estimated lost profits during the first quarter and through
the end of December 31, 20X1. Therefore, W accounts for the
entire amount as a gain contingency and does not recognize
any amount as a recovery receivable asset given that payment
is not realized or realizable.
On June 30, 20X1, the insurer pays W the
entire $100,000 and communicates to W that the payment is
nonrefundable and that there are no remaining contingencies
for the policy period through December 31, 20X1 (e.g., no
remaining due diligence is to be performed by the insurer).
The insurer also communicates to W that the $100,000 is
allocated in the following manner:
- $50,000 to fixed costs incurred through June 30, 20X1.
- $25,000 to estimated fixed costs to be incurred from July 1, 20X1, to December 31, 20X1.
- $10,000 to estimated lost profits during the period from January 7, 20X1, to June 30, 20X1.
- $15,000 to estimated lost profits during the period from July 1, 20X1, to December 31, 20X1.
In its June 30, 20X1, financial statements,
W recognizes the entire $100,000 insurance payment in
income. Because all contingencies have been resolved upon
receipt of the payment, the gain contingency is considered
realized and should be recognized in the financial
statements at that time without deferral over the remaining
periods of estimated fixed costs to be incurred and future
estimated lost profits. Although W predicts that the retail
store will be inoperable until the second quarter of 20X2,
it would not be appropriate for W to recognize the proceeds
over the remaining period of inoperability or the remaining
period in the policy through December 31, 20X1, because the
final settlement received on June 30, 20X1, is no longer a
contingency.
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.
ASC 220-30
50-1 The
following information shall be disclosed in the notes to
financial statements in the period(s) in which business
interruption insurance recoveries are recognized:
- The nature of the event resulting in business interruption losses
- The 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.
4.7 Balance Sheet Presentation — Offsetting
ASC 210-20-20 defines a right of setoff as “a debtor’s legal right,
by contract or otherwise, to discharge all or a portion of the debt owed to another
party by applying against the debt an amount that the other party owes to the
debtor.” A right of setoff exists when all of the criteria in ASC 210-20-45-1 are
met.
ASC 210-20
45-1 A right of
setoff exists when all of the following conditions are
met:
- Each of two parties owes the other determinable amounts.
- The reporting party has the right to set off the amount owed with the amount owed by the other party.
- The reporting party intends to set off.
- The right of setoff is enforceable at law.
An entity that purchases insurance from a third-party insurer generally remains
primarily obligated for insured liabilities; however, the entity should carefully
evaluate the insurance contract and applicable laws. Under U.S. GAAP, it is only
appropriate to offset assets and liabilities when the four above conditions in ASC
210-20-45-1 for the existence of a right of setoff are met.
It is not appropriate to offset a receivable for a probable
insurance recovery against a contingent liability unless the requirements of ASC
210-20 are met. In such circumstances, the conditions for offsetting would typically
not be met because an insurance receivable and claim liability generally would be
with different counterparties. For example, insurance proceeds received by the
reporting entity are usually from a third-party insurer, whereas the contingent
liability related to claim liabilities would be to a party other than the
third-party insurer.
4.8 Income Statement Classification of Loss Recoveries and Gain Contingencies
As discussed in Section 4.6, 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).” Further, ASC 410-30 provides guidance on the
income statement presentation of environmental remediation costs and related
recoveries, such as insurance recoveries. ASC 410-30-45-4 states that “environmental
remediation-related expenses shall be reported as a component of operating income in
income statements that classify items as operating or nonoperating. Credits arising
from recoveries of environmental losses from other parties shall be reflected in the
same income statement line.”
Although authoritative income statement classification guidance does
not exist for many other types of loss recoveries, such as involuntary conversions,
in practice, entities have generally applied the guidance in ASC 410-30 by analogy
when determining the appropriate classification of other loss recoveries.
For recoveries in which the recovery proceeds exceed the incurred
loss, resulting in a gain, an entity should consider other authoritative literature,
including applicable SEC regulations (e.g., SEC Regulation S-X), when determining
whether it is appropriate to classify the gain within the related income statement
line item as the loss recovery. Depending on the nature of the gain, entities should
consider whether it is appropriate to classify it as operating or nonoperating. In
determining whether it is appropriate to classify a loss, a loss recovery, or a gain
as operating or nonoperating, entities may consider SEC Regulation S-X, Rule 5-03.
Although Rule 5-03 does not define items that should be classified as operating, it
does provide examples of items that should be classified as nonoperating.
Entities should provide sufficient disclosure, if material, to
enable financial statement users to determine in which financial statement line item
the gain has been recognized.
4.9 Classification of Insurance Proceeds in the Statement of Cash Flows
ASC 230-10-45-21B states that “[c]ash receipts resulting from the
settlement of insurance claims, excluding proceeds received from corporate-owned
life insurance policies and bank-owned life insurance policies, shall be classified
on the basis of the related insurance coverage (that is, the nature of the loss).”
In addition, for lump-sum settlements, “an entity shall determine the classification
on the basis of the nature of each loss included in the settlement.”
Entities should determine the classification of insurance receipts
that have aspects of more than one class of cash flows by first applying specific
guidance in U.S. GAAP. When such guidance is not available, financial statement
preparers should separate each identifiable source of cash flows on the basis of the
nature of the underlying cash flows. Each separately identified source of cash
receipts should then be classified on the basis of its nature. Classification based
on the activity that is most likely to be the predominant source or use of cash
flows is appropriate only when the source of insurance receipts has multiple
characteristics and is not separately identifiable. For additional information on
the determination of more than one class of cash flows, see Section 6.4 of Deloitte’s
Roadmap Statement of Cash
Flows.
For example, insurance settlement proceeds received as a result of a
claim made in connection with the destruction of productive assets should be
classified as cash inflows from investing activities because the settlement proceeds
could be analogous to proceeds received on the sale of such assets. However,
proceeds received as a result of claims related to a business interruption should be
classified as operating activities.
Example 4-7
Business Interruption
Cash Flow Classification
A flash flood destroys a fleet of RVs and a
building at the corporate headquarters of RV Company XYZ,
leaving the RV dealer inoperable for three months until it
can restock its inventory and repair the corporate
headquarters. RV Company XYZ has property and business
interruption insurance that covers lost profit margins, lost
inventory, and damaged equipment and property. Covered
losses under the insurance policy include natural disasters,
such as floods. RV Company XYZ receives a lump-sum insurance
payment of $85 for lost profit margin, lost RV inventory,
and corporate headquarters repairs. In a manner consistent
with the submitted claim, XYZ determines that $15 should be
allocated to lost profit margin, $45 to damaged inventory,
and $25 to rebuilding a portion of the corporate
headquarters.
RV Company XYZ appropriately classifies the
insurance receipt in the statement of cash flows as
follows:
- $15 lost profit margin = operating inflow.
- $45 lost inventory = operating inflow.
- $25 corporate headquarters reconstruction = investing inflow.
4.10 Subsequent-Event Considerations
Entities should evaluate events that occur after the balance sheet
date but before the financial statements are issued or are available to be issued to
determine whether the events should be recognized in the current-period financial
statements or in the subsequent-period financial statements. The recognition,
measurement, and disclosure principles related to loss recoveries that are described
in this chapter apply to the period after the balance sheet date but before the
financial statements are issued or are available to be issued.
After the balance sheet date, there may be a recovery of a loss that
exceeds the amount of a loss previously recognized on or before the balance sheet
date, resulting in a gain after the balance sheet date. The recovery should be
treated as two separate units of account:
- Loss recovery — The amount of the recovery equal to the previously recognized loss.
- Gain contingency — The amount of the recovery in excess of the previously recognized loss.
The recognition of these two units of account will differ in a
manner that is consistent with the different loss recovery models described in this
chapter. A recovery asset (e.g., a receivable) for the amount of the recovery equal
to the previously recognized loss should be accounted for as a recognized or
nonrecognized subsequent event in a manner that is consistent with the recognition
threshold for loss contingencies.
If an event occurs after the balance sheet date but before the
financial statements are issued or are available to be issued, and the event
indicates that a loss recovery is probable (or the loss recovery has been received)
for a loss incurred on or before the balance sheet date, the event provides
additional evidence of the recovery and should be accounted for as a recognized
subsequent event. Examples might include (1) the probable receipt of insurance
proceeds equaling the loss incurred related to a plant that was destroyed on or
before the balance sheet date or (2) proceeds from a lawsuit settlement in the
amount of a previous loss incurred for litigation that arose on or before the
balance sheet date.
The amount of the recovery in excess of the previously recognized
loss would be accounted for as a nonrecognized subsequent event because to realize
the gain recovery would be to recognize income before it is realized, as described
in ASC 450-30-25-1. Accounting for the two units of account by using separate
recognition thresholds is consistent with the subsequent-event treatment of loss
contingencies and gain contingencies discussed earlier in this Roadmap. Further, the
treatment of the loss recovery and the gain contingency as two separate units of
account is consistent with the involuntary conversion guidance in Section 4.2.
Example 4-8
Accounting for Insurance
Proceeds Comprising a Loss Recovery and a Gain
Contingency
Company P is a public company with a
calendar year-end of December 31, 20X8. On December 24,
20X8, a flood severely damages P’s operating plant. Company
P determines that it has incurred a loss of $500,000 because
of the flood damage and therefore recognizes the $500,000
loss as of December 31, 20X8. On February 19, 20X9, before
the issuance of P’s financial statements, the insurance
company notifies P that it will pay insurance proceeds in
the amount of $750,000, subject to the completion of the
insurance company’s investigation process.
Company P has previously received insurance
proceeds from this insurance company in connection with
other damages and is therefore familiar with the ongoing
investigation process. Company P determines that it is
probable that the investigation will not change the
anticipated recovery of $750,000. Therefore, as of December
31, 20X8, P recognizes a loss recovery asset as a recognized
subsequent event in the amount of $500,000, which is the
amount equal to the previously recognized loss. The
remaining $250,000 is subject to the gain contingency
guidance; therefore, the notion of probability is
irrelevant. Since there are unresolved contingencies as of
the balance sheet date of December 31, 20X8 (i.e., the
ongoing investigation), the $250,000 does not reach the gain
contingency recognition threshold described in Chapter
3 and therefore constitutes a nonrecognized
subsequent event and should not be recorded as of December
31, 20X8.