Complexities in booking insurance claims: natural disasters can leave millions of dollars in damages in their wake. Cleaning up the physical mess is one thing. Preparing the insurance claim and accurately accounting for the damage can be a whole other matter.

• Author: Melton, Allen

Fires, hurricanes, earthquakes and floods cause millions in damage to businesses every year, leading to hardship and headaches. But they can generally be managed, with the business returning to normal operations quickly.

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Accounting for such a loss, however, presents significant challenges for financial executives, including how to correctly book losses, liabilities, recovery costs and settlement income. How such complex claims affect a company's financial statements--in light of typical circumstances that arise in booking losses and settlements following property damage and business interruption loss--has not received enough public attention.

This article addresses several of the critical accounting considerations facing financial executives, through examination of a typical case study based on actual challenges faced by several different companies.

A Case for Review

It's late September. A hurricane whips through the Gulf of Mexico, with Category-3 force winds lashing the South and Midwest. Our hypothetical company, UL Beverage Co, is a soft-drink concentrate manufacturer whose Kentucky plant is damaged by high winds. The facility's two production lines had been running 24/7 before the windstorm hit; a third line had been idle.

UL is in a bind. Its most important facility is shut down, most equipment is destroyed and little is repairable. But outsourcing production is not an option, because the company's soft-drink recipe, ingredients and syrup production process are trade secrets, and the only facilities with the ability to contract for added production also have privileged relationships with UL's competitors.

UL quickly shifts production, shipping ingredients and moving personnel to its smaller facility in California and rents storage space for undamaged inventory and materials. But output is 75 percent lower there than what the Kentucky facility could produce, and labor costs are higher. By year's end, batches of pre-mixed ingredients are still trucked daily from storage to the California plant. And UL must pay more to ship finished product east.

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UL Beverage starts to rebuild its Kentucky plant immediately--to restore two lines in full. To keep its experienced team, the company continues to pay its employees after the loss. By year-end, reconstruction is well underway. But now the chief financial officer must consider how to calculate the company's losses, address different insurance coverage, and plan for anticipated settlement income in the months ahead.

Determining the Loss

The first objective is to determine the company's specific losses--including lost revenues, damaged or lost equipment, extra expenses and personnel costs. UL would have a complicated equation to address: Increased production costs, storage and transportation expense, calculation of lower revenues from existing contracts, additional labor, among other considerations.

Let's say UL Beverage had typical property insurance coverage on its facilities...