Accounting for Disasters and Insurance Proceeds: Is Your Resort Prepared?

Dealing with insurance claims can be a daunting task. Resolutions that meet the needs of the interested parties that are also agreeable to the insurance carriers are not easily achieved and can involve a substantial amount of time and effort on the part of the claimant. Mutually agreeable resolutions become increasingly more involved as the size of the claim increases. With damages in recent years resulting from increased activity of hurricanes, tornadoes, fires, and other natural disasters, resorts have had their hands full.

Probably the least of anyone’s worries, but to add another layer of complexity, there is plenty of uncertainty and diversity in practice in accounting for these claims from a financial statement perspective. Following the massive devastations of Hurricanes Katrina and Rita in 2005, the need for accounting guidance was evident. As a result, guidance was released by the American Institute of Certified Public Accountants (“AICPA”) that provided an overview of accepted accounting methods for these types of situations. While the guidance provided a general overview that can be applied to many industries, it can easily be interpreted how vacation ownership resorts should treat such matters. The guidance issued by the AICPA covers four main areas: impairment, insurance recoveries or proceeds, required disclosures, and the use of a separate fund to account for the damages. The following discussion will address the salient points of the guidance applicable to resort operators and managers.

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Most vacation ownership resorts do not have significant capitalized property, and in general common property (i.e. buildings, elevators, furnishings, common areas, possibly amenities, etc.) is not capitalized on a resort’s financial statements. Developers and entities that own parts of these types of assets would have them recorded. Either way, if an entity has capitalized assets on its balance sheet, those assets should be evaluated for impairment if they were damaged by a natural disaster. If it has been determined that an impairment exists after evaluation (i.e. the carrying value exceeds the fair value), the entity needs to determine the amount of the asset’s carrying value which is not recoverable that exceeds the fair value. This impairment loss should be recognized in the period the impairment occurs, which may be the same period as the natural disaster regardless of when any proceeds may be received.

Insurance Recoveries or Proceeds

Under accounting guidance, an involuntary exchange occurs when a damaged resort asset (non-monetary) is exchanged for monetary assets (insurance proceeds). These types of transactions represent gain contingencies if they are still open at the end of a year and should not be accrued (i.e. recorded as a receivable) until the realization of the insurance recoveries are estimable and probable. Common practice defines probable as “likely to occur” and should consider whether all contingencies related to the claim have been resolved. If the insurance claim is subject to litigation, settlement negotiations, adjustor evaluations, or other uncertainties, it is generally not considered probable. At the time the recoveries are both probable and estimable, the entity should record them in the financial statements in the period the criteria were met. If the recoveries relate to assets that have not been capitalized, such as common property of a vacation ownership resort, the proceeds should be recorded as revenue in the financial statements. On the other hand, if they represent recoveries for a previously capitalized asset, the entity should recognize a gain or loss from the difference between the carrying value disposed of and the proceeds received.

Other factors to consider include the nature of the loss, the timing of the loss, and the ability of the insurer to fulfill the claim.

Example of Accounting Treatment:
For example, if in 2018, an entity filed an insurance claim for property damages but had not determined the amount and likelihood of collection by December 31, 2018, no revenue or related receivable would be recorded for 2018. Once the insurance claim was approved and collection was deemed probable (and estimable), the revenue and related receivable would be recorded in the period the claim met these criteria in a later period. On the other hand, using similar facts above, if the amount of insurance proceeds was determined to be probable and estimable as of December 31, 2018, the revenue and receivable would then be recognizable in the 2018 financial statements. Whether the revenue is recorded at gross or net is determined by whether the entity capitalized the assets damaged.

Property Damages and Liabilities

The accounting for loss contingencies is similar to that of gain contingencies, although measuring the likelihood and amount of the loss liability may be different. It is rarely difficult to see that a loss has occurred, especially when discussing property losses from natural disasters. The “loss” can represent any costs needed to bring the property back to working order, including but not limited to contractor costs, sales taxes, assembly, and installation. In the case of vacation ownership resorts, this may include expenses typically recognized in the replacement fund as well as general repairs and maintenance costs. The difficulty arises when trying to estimate the amount of the loss. Regardless of whether the costs to repair or replace property are attributed to capitalized or non-capitalized property (association common property), the liabilities and associated expenses or construction in progress should be recognized in the period the loss occurred. Although proceeds may be delayed, expenses should not be deferred on the balance sheet and should be recorded as expenses when incurred.

In many cases, insurance proceeds are received in a different period than the related expenditures are incurred. As a result, revenue and expenses could be recognized in different periods resulting in drastic reporting differences from year to year.

Insurance Proceeds Versus Insurance Expenditures

It is not uncommon for the costs of repairs to exceed the amount of insurance proceeds received, especially when there are large deductibles to consider. When this occurs, an association has the right to charge a special assessment to the owners, obtain financing, or find other methods to complete the necessary repairs. Alternatively, if the amount of the insurance proceeds exceeds the amount of the repairs, the association must decide how to use the additional funds. Although not a common occurrence, if the proceeds do exceed the costs of repairs made a resort’s board of directors must decide how to handle the excess funds.

Insurance Fund

Although not required, some timeshare associations create an insurance fund in addition to the operating and replacement fund to better track incidences of natural disasters and manage the impact, while avoiding the commingling the funds related to the insurance proceeds and expenses. Many resort governing documents have specific guidance on how to treat substantial losses in these situations, and boards and management should be sure to refer to these documents when accounting for losses.

Business Interruption Income
In addition to the physical losses incurred as a result of an insurable event, a resort may incur business interruption loss associated with the resort being unable to operate. Common examples of business interruption loss include lost rental income, lost food and beverage income from resort food and beverage services, or lost recreational revenue. This insurance reimbursement, if applicable, would be considered a gain contingency and requires that all contingencies related to the reimbursement be resolved and collection be estimable and probable in order to be recorded in the financial statements.

Financial Statement Presentation Matters

Balance Sheet
Insurance recoveries receivable and associated liabilities do not generally meet the conditions to offset and should be recorded separately on the balance sheet. This is a result of the fact that typically the insurance carrier is not the entity engaged to complete the repairs and the association would not have the legal right to offset unpaid claims with incurred repair or re-construction costs.

Statement of Cash Flows
Classification of proceeds received should be classified on the statement of cash flows based on the nature of the loss recorded. Accordingly, recoveries associated with rental income loss would be recorded in operations while proceeds related to loss of a building asset would be shown as investing activities.

Disclosure Requirements
Loss Contingencies: Disclosure requirements generally have a broader range than the actual recording of a contingency. For example, disclosure in the financial statements of the nature of a loss contingency is required when the loss is “reasonably possible” in contrast to “probable”. A disclosure could be required even when the actual accounting for the loss does not meet the criteria for recording.

Going Concern: In certain cases, the natural disaster may have caused such severe devastation that a resort’s ability to continue as a going concern is in jeopardy. When this issue arises, detailed descriptions of the events causing the doubt and management’s plan to overcome it are required.

Subsequent Events: If a natural disaster occurs after a year end, but before a financial statement is issued, detailed disclosures of the event and financial impacts may be needed to effectively warn the reader of potential issues down the road.

Natural disasters are unpredictable and can happen at any time. When these events occur, the first steps taken by a resort’s management and board should ensure the presence and safety of all guests and owners. In the days to come, following a thorough safety assessment, the process of rehabilitation and renovation can commence. It is important to be patient and properly evaluate the results as opposed to rushing and underestimating damages. While the mental and physical repairs may not come easily, an understanding of the guidance related to accounting for insurance claims can make recording the impacts of these events easier in the aftermath. As always, a resort should consult a professional to ensure they are capturing the transactions that are occurring in the proper way and be sure to properly disclose such matters in the financial statements to keep owners and stakeholders properly informed of events.

Reprinted with permission from Resort Trades, July 2019 issue.

Author:Lena Combs, CPA, CGMA, RRP | [email protected] and Erik Halluska, CPA | [email protected]

Download: Disaster Preparedness Guide

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