January 2008

Question
The insurance policy is subject to a monthly limit and the business income and extra expense loss for the first period exceed the limit of liability.  Is it proper to amortize set-up costs over the period of restoration and not charge them all to the first period?  For example, the insured purchases a temporary office trailer for $25,000 with set-up charges of $5,000.  Is the entire $30,000 written off in the first period, or is it appropriate to charge off 1/6 of the charges per month?  The benefit derived from the expense is experienced during the entire restoration period.  If the item is accounted for incrementally, then do you also amortize the costs to remove and take down the office?  In other words, are 1/6 of the charges accounted for in the first period?

Answer

Ultimately, the answer to this question may depend on a legal or coverage determination made by the carrier. Even though there would be different accounting treatments where an insured rents v. purchases a temporary office trailer, the heart of your question seems to deal with the allocation of related costs. Additionally, it is important to determine if the insured has extra expense and/or expense to reduce the loss otherwise payable language in its policy. Assuming that the temporary office trailer is rented (not purchased), strictly used during the Period of Indemnity and there are no other saved costs, there appears to be a reasonable approach to this hypothetical question.

One of the basic accounting principles in presenting financial statements is the proper matching of "revenues and expenses" which in this instance would be analogous to matching "costs and benefits" under the extra expense provision of the policy. Since the insured must incur the cost of the lease, delivery, set-up, take-down and removal expense in order to rent the temporary office trailer, you would need to aggregate those costs and expenses. It would then seem appropriate to amortize that total aggregated amount over the six months in the Period of Indemnity to arrive at a calculated monthly amount. Having completed that calculation, the adjuster could then apply the monthly limitations to test for proper compliance under the policy.