FROM: Maria Elena Cruz Controller for Carter Hawley Hale Stores TO: Surani Vincent Chief Financial Officer of Carter Hawley Hale Stores SUBJECT: Recommendation as to the proper reporting of the earthquake damage costs in the income statement for the year ending August 4, 1990. DATE: October 27, 2010 The Emporium division of Carter Hawley Hale Stores (CHHS) suffered extensive damage due to the 7. 1 richter scale earthquake that hit the San Francisco Bay Area on October 17, 1989. The uninsured total cost of the damage was $27. 5 million ($16. 5 million after tax benefits).
For the fiscal year ending August 4, 1990, CHHS reported an after-tax loss of $9. 47 million before considering the earthquake loss. The purpose of this memo is to point out the different methods to report the earthquake loss and explain which will be the best method to use and why. On the Income Statement, losses caused by Earthquakes of large magnitude can be reported in one of two ways, as an extraordinary item, or as part of continuing operations but as a separate component of the income statement.
Extraordinary items, according to the FASB, are material events and transactions that are both unusual in nature and infrequent in occurrence.
Extraordinary items are presented separate from continuing operations, net of tax, below discontinued operations. After tax Loss before extraordinary items(*$9,470,000) Extraordinary Loss, (net of $11 million tax benefit)($16,500,000) Net Loss($25,970,000) (*After tax loss reported for the fiscal year ending August 4, 1990 before considering the earthquake loss) A material event or transaction that is unusual in nature or infrequent in occurrence, but not both, is included in continuing operations but reported as a separate component of the income statement. Operating Expenses
Loss due to Earthquake damage $27,500,000 Income tax40%(tax benefit)($11,000,000) Operating Loss ($16,500,000) After tax Loss ($9,470,000 + $16,500,000)($25,970,000) Both methods need proper disclosures notes either on the face of the income statement or in related notes. In order to determine whether or not an item can be classified as extraordinary, the environment in which the company operates should be considered. Since The Emporium Division of CHHS is located in the greater San Francisco Area, we will analyze this area to determine whether the 7. richter scale earthquake should be consider as unusual in nature, infrequent in occurrence, or both. The Greater San Francisco Area is part of the state of California which is known for experiencing hundreds of little earthquakes every year throughout the state; However, according to the U. S. Geological Survey (USGS), the probability of a large earthquake (5. 5 and up) on the San Andreas Fault (San Francisco Bay Area) in the next 30 years is about 21%, or about 1 out of 5. As described in the statistics, the 7. 1 magnitude earthquake meets both criteria unusual in nature and infrequent in occurrence.
As we have covered, in the income statement, the classification of the loss due to earthquake damage on October 17, 1989 could be reported as an extraordinary item, or included in continuing operations but as a separate component of the income statement. However, due to the analysis of the environment in which the company operates, this event can be best classified as unusual and infrequent. Finally, in my opinion, the loss due to earthquake damage should be best reported as an extraordinary item, net of tax, separate from continuing operations and below discontinuing operations.