Asset impairment
Assets potentially affected include fixed assets, goodwill, intangibles, investments, inventory, agricultural assets, deferred taxes, and receivables. You may need to assess whether an asset impairment has occurred because of flooding, land slips or other forms of destruction. In some cases, buildings or other assets may have been damaged or destroyed. In others, your operations or financial performance may be significantly affected by the loss of a key supplier, customer or another event to the point where the business cannot operate at full capacity.
When assessing impairment, you need to distinguish between assets that are damaged or impaired and those where value is impacted by changes in projected cash flows because of recent flooding:
- Assets that are destroyed, such as motor vehicles or property which suffered significant flood damage, should be written off to expense
- Assets that are damaged may need to be written down to their recoverable amount (which may be scrap or salvage value) or their useful lives may need to be revisited
- Assets impacted by changes in cash flows (e.g., output declines due to reduced demand) may need to be tested for impairment
If a natural disaster has triggered impairment indicators, an impairment test must be performed; these indicators could include:
- observable indications the asset’s value has declined during the period significantly more than what would be expected because of the passage of time or normal use. For example, this could include susceptibility of premises to flooding, structural or building integrity issues, or visible or geotechnical evidence of actual or potential subsidence; or
- evidence of obsolescence or physical damage of an asset. In many cases natural disasters damage property, plant and equipment. The wide reports of significant damage to crops and horticultural assets like kiwi fruit vines.
Asset impairments may be indicated as a direct or indirect result of the disaster. For example, damage to a manufacturing facility located in the affected region would be a direct indicator. A jump in operating costs at a facility outside the affected region, resulting from the replacement of a supplier in the region with a more costly supplier elsewhere, may be an indirect indicator. The likelihood of a supply interruption or an increase in costs being an indicator of impairment and triggering an impairment depends on the significance and duration of the expected change.
There’s also specific impairment guidance about other assets including inventory, such as flood damaged stock which will need to be written down to its recoverable amount.
Future operating losses
Your business may also anticipate having future operating losses for a period after the flood and/or cyclone. This could occur, for example, because of supply constraints, or a reduced ability to operate at full capacity.
Future operating losses and costs do not meet the accounting definition of a liability (because they do not arise from a present obligation resulting from a past event), and therefore are not recognised or provided for until incurred.
Onerous contracts
A contract is considered onerous when the unavoidable costs of meeting its obligations exceed the economic benefits it’s expected to achieve. The unavoidable costs under a contract reflect the least net cost of exiting from the agreement, whether this be either fulfilling the contract or paying any penalties for not meeting your obligations. While all types of contracts have the potential to be onerous, lease contracts are most likely become onerous. For example, a business may lease a building which has been impacted by flooding. As a result, the entity may need to find temporary premises to continue their business in the short to medium term at an additional cost, while still servicing the original lease contract. As such, unless an entity can renegotiate the original lease contract with the lessor, the business would need to assess whether the original contract has become onerous.
When a natural disaster occurs, contracts should be reviewed to determine if there are any specific terms that may relieve you of your obligations (e.g., force majeure).
Subsequent events
If your business is directly affected by a natural disaster occurring after the end of the reporting period, but before the date of issuing your financial statements, you’ll need to disclose the nature of the event and an estimate of its financial effect, or provide a statement stating an estimate cannot be made. Additionally, businesses that may be indirectly affected by the event, such as an entity with a concentration of revenue from customers in the affected area, should consider whether subsequent event disclosures are necessary as these could influence the economic decisions stakeholders make based on the financial statements.
Going concern
A decline in your operating results and financial position due to natural disasters after the reporting period could mean you need to consider whether the going concern assumption is still appropriate. If it’s not, NZ IAS 10 states the effect is so pervasive that it results in a fundamental change in the basis of accounting (typically from a going concern basis to realisation basis of preparation), rather than an adjustment to the amounts recognised within the original basis of accounting.
Financial statement disclosure
The financial statement disclosure for businesses directly and/or indirectly affected by recent flooding will vary depending on the magnitude of their losses and the availability of information.
Impairment
For each class of assets, an entity should disclose:
- Impairment losses recognised in profit or loss during the period and the line item(s) of the statement of comprehensive income in which those impairment losses are included
- Reversals of impairment losses recognised in profit or loss during the period and the line item(s) of the statement of comprehensive income in which those impairment losses are reversed
- Impairment losses on revalued assets recognised in other comprehensive income during the period
- Reversals of impairment losses on revalued assets recognised in other comprehensive income during the period
Sources of estimation uncertainty
Determining the carrying amounts of certain assets and liabilities requires estimation of the effects of uncertain future events on those assets and liabilities at the end of the reporting period. NZ IAS 1 requires disclosure of information about the assumptions concerning the future, and other major sources of estimation uncertainty at the end of the reporting period. These assumptions and estimations will have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year (except for assets and liabilities measured at fair value based on recently observed market prices). This will be particularly true if you have assets measured at fair value. Take investment property for example; fair values may be based on assumptions about future occupancy or future profitability, and/or free cash flow - all of which may be impacted by recent flooding events.
Insurance recoveries
Your business may experience a loss related to a natural disaster either through the impairment of an asset or the incurrence of a liability. For example, because of damage from flooding, an entity may determine that an item of property, plant and equipment is impaired in accordance with NZ IAS 36 or that a receivable from a customer is impaired in accordance with NZ IFRS 9. Alternatively, an entity may incur costs to repair a damaged facility or determine that it has a liability to repair an environmental damage in accordance with NZ IAS 37.
The accounting for insurance claims will differ based on a variety of factors, including the nature of the claim, the amount of proceeds (or anticipated proceeds) and the timing of the loss and corresponding insurance recovery. In addition, any accounting for insurance proceeds will be affected by the evaluation of coverage for that specific type of loss in each situation, as well as an analysis of the ability of an insurer to satisfy a claim. IAS 37 does not allow the recognition of contingent assets.
Accordingly, an insurance recovery asset can only be recognised if it is determined that the entity has a valid insurance policy that includes cover for the incident and a claim will be settled by the insurer. This may be clear from the wording of the insurance policy but could require confirmation from the insurer that the incident is covered, and an appropriate claim will be settled.
Experience from the Christchurch earthquakes and other natural disasters suggest that it might be some time after the loss event before a receivable for an insurance claim can be recognised. This is because:
- It may not be immediately obvious what is covered by an insurance policy. This is particularly true for business continuity type policies.
- Once a claim is lodged, there will be a process before the insurer acknowledges acceptance of the claim. This will typically involve the insurer using loss adjusters and other experts before they acknowledge acceptance of the claims. Access to such specialist skill may be in short supply, further extending the period between lodgement of the claim and acceptance by the insurer.
- Even once the claim has been accepted by the insurance company, you may have difficulty estimating reliably the amount likely to be received. No provision would be recognised until the quantum of any receivable can be reliably estimated.
Therefore, it is highly possible that there will be a timing difference between the recognition of any impairment loss in the current period and corresponding recognition of an insurance recovery in the next (or later) period. This will be an area of significant judgement for you and your auditor.
Ease any year-end accounting headaches early
The financial statement consequences for businesses significantly impacted by recent flooding and cyclone events will require time and careful consideration by both preparers and auditors. This is particularly true in the exercise of estimates and judgements used in the preparation of those financial statements. As such, early consideration of these matters is recommended.
