IAS 37: Your business has filed a claim, but how do you account for insurance recoveries?

David Pacey
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Many businesses continue to recover from the physical effects of extreme weather events experienced throughout the year, and will be dealing with the subsequent year-end reporting challenges. And some will also be going through the process of claiming insurance for physical loss or business interruption.  

However, accounting for insurance recoveries can be a complex task, especially when it comes to adhering to International Accounting Standard 37 - Provisions, Contingent Liabilities, and Contingent Assets (IAS 37).

Understanding IAS 37

IAS 37 is a globally recognised accounting standard issued by the International Accounting Standards Board (IASB). Its primary purpose is to guide entities in the recognition, measurement, and disclosure of provisions, contingent liabilities, and contingent assets. Insurance recoveries fall under the purview of IAS 37 when events or conditions existed at the reporting date and create a present obligation for the entity.

Recognition of insurance recoveries

The first step in accounting for insurance recoveries under IAS 37 is the recognition process. An entity should recognise insurance recoveries as an asset only when it becomes ‘virtually certain’ at the balance date as it will almost definitely receive the cash inflow. Virtually certain means the likelihood of receiving the insurance proceeds is very high.

For instance, as a result of cyclone Gabrielle, a company may have suffered physical damage to their premises and/or interruptions due to the temporary closure of the business, and file a claim with its insurer. The company should recognise the insurance recovery as an asset when it is virtually certain the insurance claim will be approved, and the funds will be received. Simply filing a claim is unlikely to meet the virtually certain threshold. Instead, it would typically require formal acceptance of the claim by the insurers before this threshold is met.

Even once the claim has been accepted by the insurance company, you may have difficulty estimating the amount likely to be received. No provision will be recognised until any receivable is reliably estimated. 

Measurement of insurance recoveries

Once insurance recoveries are recognised, the next step is to measure them. IAS 37 requires insurance recoveries to be whichever is lower of:

  • the amount of the provision made in accordance with IAS 37, which may include the cost of rectifying the contingency or the expected liability arising from it, or
  • the amount that is virtually certain to be received from the insurer.

This measurement approach ensures the entity does not overstate its assets by recording insurance recoveries in excess of the expected liability.

For example, if the estimated cost of repairing flood damage is $1 million and the insurance claim is approved for the same amount, the company would recognise an insurance recovery of $1 million. However, if the approved claim is only for $900,000, the company would recognise the lower amount of $900,000 as an insurance recovery.

Disclosure requirements

Transparency and clarity in financial reporting are fundamental principles of accounting standards. IAS 37 requires entities to provide extensive disclosures regarding provisions, contingent liabilities, and contingent assets, including insurance recoveries. Disclosure requirements include:

  • the nature and extent of the provision and the amount recognised for insurance recoveries
  • the uncertainties surrounding the timing or amount of future cash outflows or inflows related to the provision and insurance recoveries
  • reimbursements the entity expects to receive for those provisions and insurance recoveries.

These disclosures help investors, creditors and other stakeholders understand the financial impact of insurance recoveries on the entity's financial statements, and assess the potential risks and uncertainties.

Subsequent changes in insurance recoveries

Under IAS 37, changes in the amount or timing of insurance recoveries should be recognised as income or expense in the period in which they occur. This may be a different period than the one where any impairment of the damaged assets was originally recorded. 

For example, if an insurance claim was initially estimated at $1 million but is subsequently adjusted to $1.1 million due to additional damages discovered during the repair process, the entity should recognise the additional $100,000 as income in the period of adjustment.

The entity would also need to consider if subsequent event disclosure should be provided for any material settlement after the balance date but before finalising the financial statements. 

It pays to be virtually certain

Accounting for insurance recoveries under IAS 37 is essential for accurate and transparent financial reporting. Entities must recognise insurance recoveries when it is virtually certain that they will receive the funds, measure them at the lower of the provision or the amount virtually certain to be received, and provide comprehensive disclosures regarding provisions and insurance recoveries. By adhering to these principles, entities will ensure that their financial statements accurately reflect the impact of insurance coverage on their financial position and performance, enhancing the confidence of investors and stakeholders.