TO: Chief Financial Officer
DATE: August 4, 1990
SUBJECT:How to Report Earthquake Damages in the Income Statement
CHHS Inc. has suffered extensive damages due to the after math of the October 17, 1989 San Francisco Bay Area earthquake that hit at a 7.1 magnitude on the Richter scale. Twelve of the twenty-two stores have been closed for a varying period of time due to the large damages that occurred. In total, damages have summed to $27.5 million and the question is exactly how to classify these, whether it is an extraordinary item or not. Since California has many fault lines and is known to have hundreds of small earthquakes each year it is difficult to categorize this as an extraordinary item.
CRITERIA TO BE MET: Unusual/Infrequent/Materiality
Extraordinary items are defined as material events and transactions that are both unusual in nature and infrequent in occurrence (Spiceland 186). Unusual is defined as “unlike what is expected, differing in some way from the norm” (Wiktionary). Infrequent is defined as “seldom happening or occurring, rare” (Merriam-Webster). Materiality means that the loss is significant in comparison to the Net Income or Net Loss (Spiceland 186).
CLASSIFICATION OF DAMAGES:
In California an earthquake is not unusual or infrequent unless it is of high magnitude. According to Frequency of Earthquakes: Number of Earthquakes Per Magnitude Each Year Worldwide, it is safe to say that an earthquake striking magnitude of 7 to 7.9 has an annual average of 17. On the other hand, a magnitude of 2 to 2.9 has an annual average of 1.3 million. In other words, the chance of a 7 to 7.9 magnitude earthquake to strike is very low. If we compare both magnitudes to its average occurrence we can see that the earthquake in the San Francisco Bay Area is unusual and infrequent due to its extremely high magnitude that occurs rarely.
Before we can classify this as an extraordinary item...