Accounting for disasters

Japan's response to the effects of their triple natural disasters seems to be captured in their proverb ame futte ji katamaru – “After a storm, things will stand on more solid ground than they did before”. Natural disasters appear to have an uncanny sense of timing as New Zealand discovered before Japan. Apart from the unending trail of destruction, accounting for natural disasters could involve application of multiple accounting standards the financial effects of which could be significant.

Extraordinary Items

Unlike India GAAP, International Financial Reporting Standards (IFRS) do not allow recognition of Extraordinary Items. They do, however, give a leeway by emphasising on disclosure of items of income and expense that are of such size, nature or incidence that their separate disclosure is necessary to explain the performance of the entity for the period. This disclosure can be made either in the Income Statement or in the Notes on Accounts. In practice, these have been termed Exceptional Items.

British Petroleum (BP) decided to disclose the Gulf of Mexico Oil Spill as a significant event in their Notes on Accounts in 2010 after taking a hit of $40,935 million in its profit and loss account on account of production and manufacturing expenses and finance costs. This included amounts for the $20 billion trust fund created, spill response, environmental claims, litigation and claims and Clean Water Act penalties. Current obligations were provisioned for while future obligations were discounted and contingent assets disclosed.

Impairment standard

A natural disaster would bring into play the accounting standard on Impairment immediately. Management of entities that have been directly affected by natural disasters should reassess the recoverability of property, plant and equipment, goodwill and intangible assets. Some entities will need to immediately write off their physical assets while others will need to perform an impairment test to determine the effect of natural disasters on goodwill and intangible assets.

Natural disasters can give rise to an impairment indicator in circumstances where assets have been physically damaged; the business has experienced substantial declines in production; or the ability to service customers has been impeded. All of these examples can affect an entity's future profitability.

It will be important for management to assess the recoverability of loans and receivables to determine whether any losses have been incurred and need to be provided for. For some entities, inventory may no longer be in a saleable condition and must be written off; for others, inventory may be damaged and available for sale at a discounted amount. The management should estimate the net realisable amount of their inventory as at reporting date based on the most reliable evidence available.

The matching concept is given a go-by under IFRS as many entities holding insurance policies would find that there is a timing mismatch between when the loss was incurred and the recognition of the reimbursement. A reimbursement should only be recognised when the compensation becomes receivable which would invariably mean once the claim has been accepted by the insurance company.

Going-concern concept

One of the fundamental concepts of accounting — the Going Concern Concept- could be tested after a natural disaster and entities that have significant uncertainty over their ability to continue as a going concern must disclose this fact and how they plan to mitigate that uncertainty. Natural disasters that occur post period-end are a non-adjusting subsequent event because they are a condition that did not exist at the reporting date.

Where the impacts are material, the management must disclose the nature of the event and an estimate of its financial impact on the business (where possible) within its financial statements. However, if the impact of the natural disaster post period-end is so significant that the going concern assumption is no longer appropriate, the management must prepare their financial statements on a non-going concern basis

Slow poison

Deferred Revenue Expenditure as per Indian GAAP is meant for significant items of expenses the benefits of which are expected in the years to come. There have been requests for a similar sort of treatment in accounting for natural disasters — the financial impact of losses, impairments and write-downs of natural disasters should be administered like slow poison - over a period of time. They cite that these occurred due to events beyond the control of the entity and that time is the best healer for such situations. Right now, accounting standard-setters are turning a deaf ear to such requests, but a couple more Fukushima Daichi's could well make them think twice.

(The author is a Bangalore-based chartered accountant.)

COMMENT NOW