A number of companies, especially in northern Moravia and Silesia, were affected by the severe floods that swept through the Czech Republic last September. We have prepared a summary outlining the potential effects of the flood damage on the financial statements for 2024.
Damage is defined in Section 28 of Decree 500/2002 Coll., as amended (the “Decree”), as physical deterioration, i.e. irreparable damage or destruction, of intangible and tangible fixed assets and inventories (including crops). Thus, if the flood has irreparably damaged the assets and these have to be disposed of (demolition, scrapping, removal, etc.), the depreciation of their residual value is charged to “Sundry operating expenses”, specifically accounting group 54x, damage arising from extraordinary natural events.
If only part of the asset is disposed of (e.g. buildings), the carrying amount of the part being disposed of must be determined. The only guidance in the Czech accounting legislation is the Czech Accounting Standard for Businesses 013, which states that the depreciation rate of the part being disposed of is the same as that of the remainder. In practice, reporting entities most often choose either a physical ratio (e.g. 30%) or a ratio of the cost of the individual parts to allocate the carrying amount.
In order to ensure that the accounting records are conclusive, it is necessary to have records (minutes of the inventory or liquidation committee, evidence of disposal, etc.) for the disposal of assets or the liquidation of inventories. Photographic or video documentation is also advisable or required for insurance claims, etc. If the physical liquidation/disposal of the asset has not yet taken place, e.g. because the full extent of the damage has not yet been determined, then a provision must be created against the asset (see below).
These costs are usually tax deductible (see Section 24(2)(l) of Act No 586/1992 Coll., on Income Taxes, as amended).
Companies will incur high repair costs that must be recognised as a one-off cost in the statement of profit or loss as they are the cost of restoring the asset to its pre-damage condition and therefore cannot be considered technical improvement. However, it is important to note that even in the context of repairs, a company may undertake a modification that meets the technical improvement parameter, such as certain structural modifications or technology. Therefore, in specific cases (in particular for buildings), we recommend that an analysis of the costs incurred be carried out in the light of the definition of technical improvement in Article 47(4) of the Decree.
Physical damage to the asset and interruption of operations are indicators of possible impairment of the asset and therefore potential creation of a provision. We recommend referring to National Accounting Standards Board’s Interpretation I-45.
In the event that inventories are not completely destroyed by the flood, it is necessary to determine whether the price at which they are carried in the accounting records is recoverable and, if necessary, to create a provision to reflect this impairment. As a reminder, in the case of work in progress and semifinished goods, the cost of repairing the damage caused by the floods cannot be included in their value.
All costs associated with damage repair (mud and rubble removal, demolition costs) are charged directly to the profit and loss account, according to their nature (usually labour and service costs). The company should disclose a quantification of such costs in the notes to the financial statements, as this is an item that is exceptional in nature and not related to the company’s ordinary activities.
In numerous cases, when assets are disposed of (see above), some parts can be “saved” and used, for example, as spare parts. In this case, it is necessary to recognise such “newly” gained assets/inventory in the accounting records using the line “Own work capitalised” in the profit and loss account (accounting group 58x) valued at replacement cost (Section 25(1)(l) of Act No. 563/1991 Coll., on Accounting, as amended (“AA”))
If the company was insured against flood damage, duly reported the insured event and
The income from the compensation received is recognised as “Sundry operating income” in account 64x. In the notes to the financial statements, it is necessary to provide details of this income together with the related expenses (see above) and to describe its exceptional nature. Such income is not included in turnover.
This subsequent event demonstrates the fact that there was an undisputed entitlement to compensation from the insurer as well as its amount at the end of the period. Therefore, the company recognises income in a similar manner to the above and also recognises the insurance claim receivable in the “Sundry receivables” line.
In the event that compensation from the insurer has not been received prior to the date of the financial statements, the company must consider whether it can substantiate its undisputed entitlement (analysis of the insurance policy and reporting of the claim) and, if such an entitlement exists, whether it can reliably estimate the amount of the claim. Ongoing communication with the insurer can serve this purpose well. If the amount of the claim can be reliably estimated and the entitlement thereto is not in dispute, the company will recognise the expected compensation income in a similar manner to the previous cases, but will recognise the expected compensation receivable in the balance sheet within “Estimated receivables”. Any uncertainty about the determination of the amount should be described in the notes to the financial statements. If the amount of the expected compensation cannot be reliably determined or if there is doubt as to the company’s entitlement to such compensation, then the income and receivable cannot be accounted for and the receivable is disclosed only as a contingent receivable in the notes to the financial statements. We assume that a frequent occurrence of insurance claims with uncertain amounts may be
In some cases, the company may have received compensation from the insurance company but has not yet incurred the costs that the insurance claim is supposed to cover. This is the case, for example, when the company has not yet incurred the costs of repairing the damaged property. We want to stress that in such a case it would be incorrect to accrue the income from the insurance claim as the company has no liability to the insurer to pay anything in the future. If the insurance contract was set up in such a way that, upon proof of damage, the insurance claim is received regardless of the costs incurred by the company to repair the damage, or such costs may not even have actually been incurred, the entire insurance claim received constitutes income at the time it is awarded. At the same time, no reserve (see below) or estimate can be made for costs that the company may incur in the future for repairs, as the company is not obliged to incur such costs in any way. The insurance claim thus effectively covers the damage incurred, which is reflected in accounting terms e.g. in the creation of a provision (see above).
The company should consider whether it has liabilities under its contracts (especially customer contracts) that it will not be able to settle as a result of the disruption of operations and flood damage. The key element in such cases will be whether the contract contains force majeure clauses and the precise wording thereof. Thus, after a thorough legal analysis, the company may need to make a reserve for impending fines and penalties for non-performance of the contracts entered into.
We would like to point out that it is not possible to make a reserve for the cost of repairing the flood-incurred damage, nor is it possible to make a reserve for future operating losses that the company expects to incur as a result of the damage.
In some cases, the effects of flood damage (to assets and as a result of business interruption) may be so extensive that they may threaten the entity’s ability to continue as a going concern. Management has a responsibility to evaluate whether there is a fact that would materially limit the company’s ability to continue as a going concern or prevent it from continuing as a going concern for the foreseeable future. If a material uncertainty is identified, the entity is obliged to describe that uncertainty duly in the notes to the financial statements.
If the consequences of the floods are such that the company decides to cease operations, or has no other option, the financial statements must be prepared on the basis of other accounting policies (in particular, the valuation and liability recognition policies), and again, this fact must be properly disclosed in the notes to the financial statements (Section 7(3) of the AA).
Some sectors may be eligible for government subsidies in relation to the floods. In the case of subsidies, the procedure is very similar to that for insurance claims. However, the crucial issue tends to be the point at which an undisputed entitlement to subsidies arises. If the subsidy programme is not announced until after the end of the reporting period, or if an undisputable entitlement does not arise at the time the application is submitted, then a subsidy received in a subsequent reporting period cannot be treated as an adjusting event and income recognised in the current financial statements. The subsidy is only recognised as income in the subsequent period and can only be disclosed in the current financial statements in notes to the financial statements in subsequent events.
Both gifts received and provided for flood relief are recognised as Sundry operating income or Sundry operating expense when received/provided. Please note that gifts related to floods have a specific income tax treatment.
Finally, we emphasise the company’s obligation to provide sufficiently detailed information in the financial statements (in particular in the notes) to help users make economic decisions, even beyond the prescribed mandatory disclosures according to Czech accounting regulations (Section 7 of the AA). This includes in particular the quantification of costs and potential income related to flood damage and its removal.
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