Accounting for Natural Disasters - ACCA SBR Current Issues - YouTube

Welcome to Accounting Ace. In this video we're looking at the accounting implications of natural  

disasters: things like floods, volcanic eruptions, forest fires and earthquakes. There's evidence  

that many of these things are becoming more common, perhaps as a result of climate change. 

What we're focusing on in this video is solely the accounting repercussions: how do natural disasters  

impact on a business's financial statements? One  of the most obvious effects is the damage that  

natural disasters cause to assets. An earthquake might cause major damage to a business's factory  

buildings. Moreover due to that damage the factory might have lower production volumes.  

Both damage and lower than expected productivity are indications of impairment and so an impairment  

review would need to be performed. In other words the carrying amount of the asset or the  

cash generating unit to which it belongs must be compared to its recoverable amount. There may also  

be damage to inventory meaning that it cannot be sold or that it must be sold at a reduced price.  

Inventory is valued at the lower of cost and net realizable value so a loss on re-measuring the  

inventory down to net realizable value might need to be recorded in the statement of profit or loss.  

As a result of the major damage  caused by a natural disaster, 

or maybe the cost of repairing the damage, or a downturn in the local economy as a result of the  

damage, a business might decide it needs to close down some of the locations it operates from and  

actually make some of its staff redundant. This is a type of restructuring exercise and a provision  

might need to be recognized in the financial statements. Remember the trigger point for this  

is when the company has an obligation to carry out the restructuring and that's normally when a  

detailed plan has been produced by the directors and the affected employees have been notified.  

The company might already have some provisions in its financial statements relating to dismantling  

a site and clearing it up once it's finished operating in that area. Well if the business  

decides to pull out of one of these sites early then those provisions would need to be re-measured.  

This is because provisions are measured at the present value of the expenditure required to  

settle the obligation and now that the expected expenditure is much closer the present value of  

the cash flows required would be greater - they're  being discounted less heavily. On a similar idea,  

if a business does decide to pull out of an area then any leased buildings or other leased assets  

are not going to be used and this might mean that  the lease liabilities in the financial statements  

need re-measuring. The business is likely to take advantage, for instance, of break clauses - it  

might try and end that lease early and as such the lease term and the expected future cash flows will  

change and this will impact on the measurement  of that lease liability. The costs of dealing  

with a natural disaster as well as its impact on the economy might cause a business to become  

loss making. If a business makes taxable losses, remember that these can be carried forward to save  

tax on profits in the future. Consideration must therefore be given as to whether a deferred tax  

asset should be recognized. If a deferred tax asset is going to be recognized for the carry forward  

of taxable losses then the business must believe that future taxable profits are probable.

It won't just be our business which is struggling: our business' customers will be struggling because  

of the natural disaster and those customers are likely to be suffering from cash flow shortages.  

Some of them might even go bankrupt. If our business has receivables due from those customers 

then those receivables will need to be written off. Any delays in receiving money from customers  

are also going to result in an increase in the business' loss allowance. This is going  

to result in an increased expense from financial asset impairments. Finally the overall impact of  

the disaster - the impact on the business' assets, on its customers, on its cash flows -

might make it really difficult to continue trading. If a business is running out of cash it might find  

that it can't pay its debts as they fall due and we might start to doubt whether this business  

is a going concern. Any going concern uncertainties need to be disclosed in the financial statements.

And remember, if the business is not  a going concern then we need to use a  

different basis for preparing the financial statements: most commonly the breakup basis.