Christchurch earthquake one year on: an accounting perspective
Forward Focus - October 2011
Following the second major earthquake event on the 22nd of February we issued an accounting alert focused on financial reporting considerations that may arise as a result of the earthquake. So, having subsequently been through both the March and the June reporting periods, how accurate were these predictions and what have been the pivotal ones?
Impairment of assets was identified as the number one potential issue, and for a number of companies this has turned out to be the case. Companies with significant property portfolios have had to try to assess the value of their properties – difficult enough in an uncertain property market, even more so when there is restricted access to the property, hindering a complete full structural assessment. While most companies have been impacted to some extent, the most complex have been those with investment properties where the portfolio has to be recorded at fair value. Not only is there no real sales activity, rentals have been distorted by the short-term supply issues. There are pertinent questions regarding the timing of remediating damage to properties. This has required the application of significant judgements and assumptions in arriving at a valuation.
For other property assets the issues have been more around quantifying the level of impairment. Similar to the issues faced for investment property the cost of repairs are subject to significant uncertainty, often compounded by a lack of clarity regarding the condition of the land for rebuilding. The debate has started as to whether subsequent repair costs are expensed or capitalised, but for many this remains academic, as repairs have not started due to lack of access to their property and/or availability of suitable insurance cover during reconstruction.
Linked to the above are insurance recoveries. To non-accountants this would seem straight forward – if an asset has been damaged and there is adequate insurance in place, the insurance recovery should be booked as an asset offsetting the impairment to the property. If only the accounting standards were that simple! The insurance has to be treated as a separate economic event and only recognised when the asset can be reliably measured and is virtually certain of being recovered. As at 31 March and 30 June - for most entities - the insurance negotiations had not been advanced to a sufficient stage to meet these criteria and to enable insurance recoveries to be recognised.
So what have been the less expected consequences of the earthquakes from a financial reporting perspective? Even more disclosure! To ensure financial statements present the full story and to enable the users to better understand the impacts of the earthquake events, the 2011 financial statements for most entities have required more extensive disclosure of key judgements, estimates and the associated uncertainties. These have focused primarily on the assumptions made in respect of asset values, impairments and provisions.
And finally, while many businesses have previously thought of business continuity planning as a “nice to have” there is a new found respect for it. However, while many businesses had a plan for dealing with business interruption, few plans contemplated such wide scale disruption, with an entire CBD displaced with no or limited access to critical records and limited choices of alternative premises. To survive has required some innovative and flexible work practices. The lack of access to records had the potential to create accounting issues as companies prepared for their year ends. The companies that coped best were the companies with the most comprehensive and tested back-up plans and the most extensive use of electronic document storage. Those that were less diligent in their off-site back-up protocols faired less well!