When a flood, fire, hurricane or other disaster strikes your business, you may suffer heavy property damage along with lost sales during the time you’re forced to close. Having a good understanding of the accounting rules related to natural disasters can help you fully account for your losses, reduce the economic harm to your business, and obtain financial relief through insurance, tax deductions and other sources.
Accounting for Inventory Losses
Conduct a manual count of your inventory as soon it is practical to do so. Even if items are obviously a total loss, it’s a good practice to document the specific losses due to the disaster versus what you might have lost due to shrinkage or some other means before the disaster. This may also help with the insurance claims process.
You will need to update your balance sheet to reflect the current value of your remaining inventory. You can generally include inventory losses as an expense when you prepare your financial statements and file your tax return. However, you will need to adjust for any insurance reimbursements — you cannot both claim a loss expense and exclude the insurance claim from your income.
Accounting for Property Damage
Damage to other assets, such as buildings or machinery, is handled in a similar manner to inventory. If the damage is so substantial that it causes a significant decrease in the asset’s market value or prevents you from using the asset as you intended, you may be required to take an impairment loss and reduce the asset’s value on your balance sheet.
When you file your taxes, you may also be able to claim a deduction for any disaster-related decline in an asset’s value that was not reimbursed by insurance.
If your business closes or brings in additional employees during a disaster, carefully review federal law, your local laws and your employment agreements to determine whether you’re legally obligated to pay your employees.
Who Must Be Paid
Under the Fair Labor Standards Act (FLSA), you may be required to pay exempt, salaried employees during a temporary closing. In that circumstance, you may require your employees to use their paid leave time but may not refuse to pay them if they have no available leave time.
Under federal law, nonexempt employees are generally only paid according to the time they worked and are therefore not legally entitled to pay during a closing. However, your local laws or your employment agreement may require you to pay employees who were originally scheduled to work during your closing.
If you require employees to remain on-site during a disaster, you must pay them for all time during which they are not permitted to leave. This includes overtime pay if it otherwise applies.
If a disaster delays processing paychecks, you should make issuing them one of your first priorities. Willfully failing to pay your employees in a timely manner is a violation of the FLSA and may also violate state laws. While you might be excused from penalties during a power outage or when your office is inaccessible, you should not delay payroll to try to manage your post-disaster cash flow.
Extending Tax Deadlines
After a major disaster, the IRS will automatically extend tax deadlines for individuals and businesses in the affected areas. Typical extensions vary based on the severity of the disaster and the type of tax.
- For income tax returns, the extension may be several weeks or months.
- For payroll tax deposits and information statements, the extension is generally only a few business days.
Note that an extension of time to file may not include an extension of time to pay. You should continue to make estimated tax payments as close to your usual schedule as possible to avoid additional interest charges.
If a major disaster disrupts your business and you are outside of the federally declared disaster area, or some other event, such as a fire, affects only your business, you may also be eligible for relief. Visit the IRS website or speak with your accountant to learn how to apply for an extension or to have penalties abated.
Reporting Insurance Proceeds
The exact accounting treatment of insurance proceeds depends on the nature of the policy and when payments are made. However, there are a few common themes.
- Insurance proceeds should be reflected on your financial statements. Even though insurance isn’t a typical revenue or expense, it’s still important information.
- Insurance is generally a gain. However, it’s offset by the disaster losses you claim, so the net accounting effect is neutral unless your net insurance proceeds exceed your actual losses.
- Record insurance proceeds when you know how much you’ll receive. Ask your controller services about contingency reporting and how to disclose a pending claim.
While these rules may seem complex, especially if you’re currently dealing with the results of a disaster, remember that they follow general accounting concepts. The goal is to accurately report your current assets and earnings. This includes totaling up your losses so you can claim your full tax deductions and any other post-disaster benefits you may be entitled to. Having a broad understanding of the general concepts will allow you to work more efficiently with your controller services to complete the technical reporting requirements.
Dennis Najjar is co-founder of AccountingDepartment.com.
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