How to navigate Business Interruption Insurance and contingent assets

Many businesses have had to navigate a minefield of insurance claim eligibility in the last year, due to the Covid-19 pandemic. A Supreme Court ruling may have changed those policies into assets that now need to be accounted for, says Kate Arnott, head of professional services, at MHA.

At 1pm on 26 March 2020, the Coronavirus Restriction Regulations 2020 came into effect, forcing countless small and medium-sized businesses to close.

Many turned to their business interruption insurance policies to claim for loss of earnings but, in the face of such unprecedented circumstances, many found that their insurance providers were refusing to pay out, arguing that most policies were not designed to cover lengthy or prolonged pandemic interruption – unless you were the All England Lawn Tennis Club, which had been subscribing to pandemic insurance for years.

In January 2021, the Financial Conduct Authority brought a test case to The Supreme Court to consider a selection of policy wordings to set the parameters and principles for what would be considered a valid claim. The test case found largely in favour of policyholders – subject to specific policy wording. However, it remains a contentious issue with many claims still disputed.

For businesses with a valid claim, there are a number of accounting issues to be aware of, notably the point at which a business should recognise any asset in its accounts.  This comes into particular focus for firms where a departing partner may want the benefit of the Business Interruption Insurance recognised in the accounts.

For example, if a partner were to leave a partnership on 31 January 2021, where a business interruption insurance policy had been in place, following the ruling of the Supreme Court, it may be argued that there is a strong case for recognising the pay-out within the accounts up to that date. However, under UK accounting standards, that may not be the case, particularly if the value of the pay-out cannot be measured reliably.

The question is: where an insurer confirms that a business interruption claim due to Covid-19 may potentially be covered by the Supreme Court judgement, does this create an asset and, if so, how should it be quantified? Let’s take a look.

‘The Financial Reporting Standard applicable in the UK and Republic of Ireland’ stipulates that an asset should be recognised when:

“An entity shall recognise an asset in the statement of financial position when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably” (2.37).

However, the standard is unequivocal that contingent assets must never be recognised:

“An entity shall not recognise a contingent asset as an asset. However, when the flow of future economic benefits to the entity is virtually certain, then the related asset is not a contingent asset, and its recognition is appropriate” (2.38).

Instead, the requirements of the standard are that, even if the benefit is probable, it would not be recognised as an asset but rather just disclosed within (a note to) the financial statements.

“An entity shall not recognise a contingent asset as an asset. Disclosure of a contingent asset is required by paragraph 21.6 when an inflow of economic benefits is probable” (21.13).

However, where a policy type affected by the Supreme Court ruling suggests that a pay-out is virtually certain, and the amount is known, there could be a strong case to include it. Where the value is uncertain, the contingent asset would not meet the recognition criteria required by the accounting standard (and nothing would be recognised).

If you would like further advice on this issue or any related accounting matters, please get in touch.