“If the facts don’t fit the theory, change the facts” – Albert Einstein
Unlike physicists and philosophers, lawyers, adjusters and accountants don’t have the luxury of changing hard facts when measuring, evaluating and adjusting business income claims. Einstein’s universal approach, however, does not mean that facts (or data in this context) should be destroyed or created to fit a particular accounting theory, it rather means that the source of data should be curiously evaluated to come up with simple solutions to the most complex problems.
Business interruption claims can get complicated rather quickly when parties cannot agree on a methodology to measure the amount of the lost profits during the period of interruption. To resolve the stalemate, both parties will probably have to retain coverage counsel, adjusters and accountants to facilitate the claims process and streamline the coverage and measurement issues.
These teams of business income loss professionals, however, must first have a clear understanding of how the policyholder captures its financial data, to then be able to fit the data within the language of the insurance contract in question.
Bruce Smith, CPA, CFF, CFE recently stated in Accounting for Business Income Loss that:
To properly measure a business income loss it is essential to understand how economic transactions are recorded on the policyholder’s financial statements (GAAP vs. other method), and the difference and similarities between accounting and insurance terminology.
An income statement (financial statement) may be recorded on a cash basis, accrual basis, or other basis of accounting. If transactions are recorded on a cash basis, then revenue is not recorded until it is collected and expenses are not recorded until paid. If they are recorded on an accrual basis (GAAP), then revenue is recorded when earned; expenses are recorded when incurred.
The accrual basis of accounting will provide a more accurate reflection of the actual business activity during a certain period of time, as it matches revenue earned to its related costs and expenses incurred. As the business income loss calculation measures the difference between expected profit and actual profit earned during the period of interruption, an income statement prepared on an accrual basis of accounting would be the preferred method of accounting for those analyzing a business income loss. However, as previously noted, many policyholders’ income statements are not prepared on an accrual basis. Therefore, a conversion of the non-accrual income statement to an accrual basis is needed to properly calculate a business income loss.
After the data is gathered and organized, and absent clear definitions in the policy language, the team of business income professionals must choose the appropriate loss-measurement methodology. At this juncture, the deadlock between the parties will hinge on whether the insured’s ability to generate revenue and profit can be truly predicted with the data that existed before the loss occurred or whether post-loss market conduct should be considered as part of the equation.
Not all businesses are alike and not all keep their operational data in the same manner. It is therefore impossible to measure all business income losses “with the same ruler” and the facts must sometimes “change” to fit the theory of recovery.
