Houses and offices under water. Looting in the streets. Factories on fire. What's an accountant to do?According to the Financial Accounting Standards Board's Emerging Issues Task Force, treat the situation as ordinary.
Were it an asteroid hitting Miami or a tsunami washing over Nebraska, the accounting treatment could recognize an extraordinary event. Related costs would be banished from "income from continuing operations" on the income statement just as surely as looters are banished from New Orleans.
The difference? Southern cities suffer frequent hurricanes. Levees break. Water collects in low spots. Despite President Bush's surprise, just such a disaster had been all but predicted. From an accounting point of view, neither severity nor human suffering affects the ordinariness of expectable disasters. The weather, no matter how cruel, is an ordinary cost of doing business.
The existing standards apply to Katrina-related disasters as much as they do to disasters of smaller scale. With undertones of regret that accounting has no way to wipe away the financial impact of Katrina's devastation, FASB issued a brief explanatory statement:
"As tragic as hurricanes and other natural disasters are for everyone affected, unfortunately, every year many businesses across the country are affected by these types of events, and thus they do not represent an unusual and infrequent occurrence to businesses or to insurers. So while 'extraordinary item' treatment may not be appropriate, current accounting standards do permit separate 'one-line' break-out of the effects of such events on the face of the income statement with amplification through full and informative disclosure."
But the board has not given up on the possibility of financial statements better reflecting the impact of disaster. FASB spokesman Gerard Carney explained that the difference between Katrina's physical and fiscal impacts underscores the importance of the board's project on reporting on financial performance. The project is exploring ways to better present and display information in the income statement - differentiating, for example, between operating and non-operating or recurring and nonrecurring costs.
Type II subsequent events
But extraordinariness isn't the only question for auditors to consider. Here's another: Suppose a Katrina's blowing in just as you've finished performing your meticulous fieldwork procedures. You've signed the audit report, and you're on the way to the post office. But before you arrive, the post office and the client's manufacturing plant get blown into the Gulf of Mexico. The company was a going concern when you finished the audit, but now it's a gone concern.
Fortunately, you and your audit report have survived, but now you have to answer a big question: Should the disaster be reflected in the financial statement that you just signed? If so, the statement is looking beyond its own closing date, and the auditor is opining on something outside the scope of the audit.
On the other hand, if the disaster goes unreported, the auditor is signing off on a statement that is patently misleading.
In response to desperate queries from Katrina victims arriving at the American Institute of CPAs, the institute has produced a technical practice aid to help auditors understand their obligations under such exceptional circumstances.
A TPA is a non-authoritative document that only serves to clarify a given issue. It is typically presented in a simple question-and-answer format.
Michael Glynn, AICPA technical manager, was instrumental in developing the TPA on short notice. "Although the technical practice aid was written in such a way as to extend to all natural disasters," he said, "it was specifically written to address audit-related concerns relating to the effects of Hurricane Katrina on client operations."
According to the TPA, the fiscal effects of the event should not be reported in the balance sheet, and the auditor is not required to look for such events.
But an auditor wouldn't have to look hard to notice something seriously amiss in Gulfport or Biloxi, Miss., or New Orleans. Such an obvious disaster would be considered a "Type II subsequent event," according to the TPA, and as such, the event may have to be dealt with in the financial statement.
In such a case, the practice guidance says, management and the auditor would have to assess the damage and the impact on the company's current and future operations, and decide whether the financial report would be misleading if the event were not in some way reflected.
The guidance explains that a Type II subsequent event may be disclosed by supplementing the historical financial information with pro forma financial data giving effect to the event as if it had occurred on the date of the balance sheet. The auditor may even decide that the event had so much impact that it must be emphasized in the audit report. If it brings into question the company's ability to continue business, the auditor can include an explanatory paragraph to reflect that conclusion.
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