Question

An entity operates 5 gas stations and owns all the land and buildings where the gas stations operate. The entity chooses not to insure all of its gas stations from the risk of fire, but does its own calculation of the probability of a fire. Based on calculations by management, there is a risk of fire with a loss of $ 100,000,000 for every 5 years. Accordingly the entity recognizes an expense of $ 20,000,000 every year in the event of a fire and recognizes a liability. The management's reason is that the risk of fire is huge and if management chooses to use insurance services, insurance costs will continue to arise each period.

Asked: Give your opinion on the acknowledgment of the expense and liability of the management! Is it in accordance with the recognition as set out in the basic framework?

Answer 1

As per accounting standards, when the probability of incurring the loss is more than 50%, then the management has to recognize the loss as provision and defer the loss for the period expected to incur the loss. Even when the entity had incurred insurance cost the same needs to be accounted in the same year. Similarly as the loss expected is $ 100,000,000 and its for 5 years the same needs deferred over 5 years i.e $ 100,000,000/5 years = $ 20,000,000 and the same to be accounted every year.