Appreciating Depreciation Consideration of depreciation as a saved expense in the context of fully destroyed and replaced assets is well-trodden ground. But what about the question of how best to deal with depreciation savings for undamaged assets in a business interruption claim?
Timothy Zimmerman
Senior Manager, Litigation Accounting and Valuation Services, Collins Barrow Toronto LLP
From an accounting perspective, it is generally quite clear that when an asset is destroyed as a result of a peril (for example, fire or flood) the depreciation on that asset ceases. This, in turn, results in the depreciation expense being saved by the insured. But what happens when an asset is not damaged? Should depreciation on those assets be considered a saved expense? Depreciation is a non-cash expense used to allocate the cost of an asset over its useful life (most assets lose their value over time and must be replaced once reaching the end of their useful life). There are four principal causes of depreciation: 1. functional — asset declines in productivity or service over time; 2. physical — asset deteriorates due to environmental factors over time; 3. technological — asset become obsolete from improved technology; and 4. economical — asset devalues as a result of economic factors. Now consider how things might play out when there is a fire involving an insured who owns and operates a small stamping business with
50 Canadian Underwriter February 2015
two major assets: an extravagant rotating sign — which has a useful life of 10 years based on the gradual deterioration from weather — out front of the business that the insured depreciates using the straight-line method (depreciation is charged uniformly over the life of an asset); and a stamping machine that has an estimated useful life of 100,000 stamped widgets that the insured depreciates using the units of production method (depreciation is charged based on the actual usage of the asset). Assume a fire occurs at the insured’s premises. The building is destroyed, including the stamping machine, but the sign remains undamaged. As a result of the fire, the business is unable to operate in any capacity for 12 months. It is clear that since the stamping machine was totally destroyed, any depreciation that would have been incurred on the machine would be saved. But would it be appropriate to consider any depreciation saved on the undamaged sign? Alternatively, what if an uncontrolled truck drove off the road, destroyed the sign and went through the building, but the stamping machine was undamaged? Since the sign was totally de-