ASC 720-45: Business Interruption Insurance Accounting

The Accounting Standards Codification provides the framework for how companies account for recoveries from business interruption insurance. The guidance ensures that income from these insurance policies is recognized in the appropriate accounting period and applied consistently. This standard establishes specific criteria for when a company can record the proceeds and how that income should be presented in its financial statements, helping investors understand the financial impact of a disruptive event.

Scope of Business Interruption Insurance Accounting

Business interruption insurance is designed to cover the profits a company loses and the continuing operating expenses it incurs following a disruptive event that halts or slows down its operations. These policies are intended to restore the business to the financial position it would have been in had the disruption not occurred. Covered expenses typically include items like payroll for retained employees, rent or lease payments, and other fixed costs that continue even when revenue-generating activities have ceased.

This type of insurance is fundamentally different from property insurance, which specifically covers the cost to repair or replace physical assets that have been damaged or destroyed. For instance, if a factory fire destroys a production line, the insurance reimbursement for the new machinery falls under property loss accounting. The separate payment to cover the lost income and ongoing salaries while the factory is non-operational is the portion governed by business interruption insurance accounting rules.

This distinction is important for financial reporting, as the accounting treatment for each type of recovery differs. Funds for property damage are netted against the book value of the destroyed asset to calculate a gain or loss. In contrast, the recovery for lost profits and continuing expenses is treated as a form of income, subject to the specific recognition rules.

Recognition Criteria for Insurance Recoveries

Under U.S. Generally Accepted Accounting Principles (GAAP), these potential insurance recoveries are classified as gain contingencies. A gain contingency is a potential financial gain that is dependent on the occurrence of a future event to be confirmed. This classification means a company cannot record income prematurely or based on assumptions about the claim’s outcome.

The core principle dictates that income from a business interruption claim can only be recognized when the underlying contingency is resolved. Resolution occurs when the insurance carrier formally acknowledges its liability to pay the claim. The amount of the recovery must either be received in cash or be probable of collection and reasonably estimable.

For example, if a business suffers a qualifying loss in December but the insurance company has not agreed to the claim amount by the end of the financial year, no income can be recorded in that year’s financial statements. The potential recovery would instead be disclosed in the notes to the financial statements if it is material. The income is only recognized in the subsequent period when the insurer formally approves the claim.

Measurement and Income Statement Classification

Once the criteria for recognition have been met, the next step is to determine the amount of the recovery to record. The measurement principle limits the recognized insurance recovery to the amount of actual losses and expenses incurred up to the reporting date. A company cannot recognize a gain that exceeds the cumulative lost profits and continuing normal operating expenses that the policy is intended to cover.

If a business interruption event affects multiple financial reporting periods, the insurance recovery is recognized as the related losses and expenses are incurred. For instance, if a company expects a $1 million total recovery over ten months, it would not recognize the full amount when the claim is approved. Instead, it would recognize portions of the recovery in each period to offset the specific losses and expenses incurred during that same period.

Regarding classification on the income statement, a company can present the recovery as a separate line item, often labeled “Other Income” or “Insurance Recoveries.” This approach offers transparency by clearly identifying the amount of income received from the insurance settlement.

Alternatively, the recovery can be netted against the specific expenses it is intended to reimburse. For example, if a $100,000 recovery is meant to cover ongoing payroll and rent, that amount could reduce the reported “Salaries Expense” and “Rent Expense” line items. The choice of presentation must be applied consistently.

Required Financial Statement Disclosures

Financial statement disclosures provide necessary context for users to understand the nature and impact of the business interruption and the related insurance recovery. Companies are required to describe the nature of the event that led to the business interruption, providing details about the incident and its effect on operations.

The disclosures must also state the total amount of insurance recoveries that have been recognized as income during the reporting period. Alongside this amount, the company must specify the line item or items on the income statement where the recovery is classified. This clarification is needed whether it is presented as a distinct “Other Income” item or netted against expenses.

A company must also disclose the existence of any material gain contingencies that have not yet been recognized because the conditions for recognition have not been met. If a company has filed a significant insurance claim but the insurer has not yet admitted liability, the potential recovery cannot be recorded as income. However, the nature of this contingency and an estimate of the potential recovery range must be disclosed in the notes.