Memo to CEO – Earthquake Loss Reporting

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As you know, our retail company has experienced significant and extensive damages as a result of an Earthquake. The reporting for such a loss is guided by Generally Accepted Accounting Principles (GAAP) and the impact of such a loss on the company’s income statement is contingent upon the nature and characteristics of the earthquake. The earthquake hit the San Francisco Bay Area, the area in which we operate retail stores, on October 17 of this fiscal cycle. The Richter scale measure was 7.1 in magnitude. Of our twenty-two stores, twelve had to be closed for periods of time due to damages. The projected loss has been assessed at $27.5 million. I have been tasked with providing clarity to the situation and making a recommendation on how the company should report this loss. The question at hand is whether or not the loss can be included in the income statement as an extraordinary loss.  

To be classified as an extraordinary loss an event must meet certain criteria under GAAP. In general, the event must be unusual in nature and have the quality of infrequency in occurrence. Unusual is defined as unlikely to occur and different from the established norm. Infrequent is defined as rarely occurring. The argument to meet these criteria and report the loss as extraordinary begins with fitting the description of unusual. In the area in which our Company operates, earthquakes are not considered unusual. There are many earthquakes that occur along the San Andreas Fault line every year. This position also addresses the criteria of infrequency in occurrence. Again, the criteria are not met.   

The remaining argument in response is to state that an earthquake of such significant magnitude and destruction does, in fact, fit the criteria of unusual and infrequent. This is a very valid argument; however, the GAAP has released several formal responses to address the accounting of disaster and extraordinary loss criteria. While we may argue that the Company’s loss does fit the definition of criteria, the GAAP has set precedent in a formal response to other comparable disasters. 

Businesses in Louisiana wished to list their losses as a result of Hurricane Katrina. A hurricane was not unusual or infrequent in the area; however, the magnitude of the hurricane did seem to fit these criteria. Businesses also wished to list the losses as a result of the September 11 attacks as an extraordinary item (Rosen 39). Again, the bombing was not unusual and infrequent because the trade towers had been bombed several years prior. The businesses argued that the magnitude of the attack supported the argument for unusual and infrequent. The assumption-setting branch of the GAAP released a formal response that stated “one might reasonably expect that type of activity of nature to strike again in greater or lesser magnitude of damage” (TPA 5400.5)

Regrettably, I have to recommend that the company not list the loss as an extraordinary item on the income statement. While the definition of the event and our belief that this loss is extraordinary, unusual, and infrequent, it does not fit the criterion established by GAAP. The argument that the magnitude of the disaster allows the classification of extraordinary has been struck under GAAP in the U.S. The appropriate accounting response is to recognize the impairment of the property assets and have that amount written off. Consideration should be given to mitigate future losses such as this with adequate insurance protection. The extent of damage is so significant that another loss of this magnitude is not bearable. 

Works Cited

"Accounting and Disclosures Guidance for Losses from Natural Disasters – Nongovernmental Entities ." AICPA Technical Aids 1 (0): n. pag. TPA 5400.5. Web. 22 Sept. 2013.

Al, Rosen. "It's extraordinary." Canadian Business 74.21 (2001): 39. Print.