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What is the basic formula for calculating net income?
Net Income = Revenue - Expenses
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Can a business that is not making profit experience a business income loss? Briefly explain.
Yes, because a slowdown or shutdown can increase the net loss.
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How is the net income loss during a business interruption affected by noncontinuing expenses
Each dollar of expense that does not continue during a shutdown increases the net income (or decreases the net loss) by the same amount.
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Why would an organization willingly incur extra expenses during a business interruption?
An organization might willingly incur extra expense during a business interruption to maintain essential services, to avoid a shutdown that could impair their good will relations, or avoid to reducing their long-term market share.
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Describe the four ways in which extra expenses might be incurred during a business interruption in order to reduce the business income loss?
- 1) renting temporary premises or equipment
- 2) moving to and from temporary premises
- 3) Notifying customers
- 4) paying an extra cost (such as overtime or bonuses) to obtain needed labor.
- many answers possible.
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Identify three types of dependency that can create a business income exposure involving property other than that at the insured's own premises.
Dependency on key suppliers, dependency on key buyers, and dependency on leader properties in a retail setting can create such an exposure.
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How can the act of a civil authority at one place cause organizations located elsewhere to sustain a business income loss?
A civil authrity (such as the police or fire department) can close an entire street or area to traffic because of an unsafe condition. This action might prevint occupancy, resulting in a loss of business income.
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What factors affect the length of a business interruption?
The length of a business interruption depends on 1) how long it will take to repair or replace damaged property and 2) how long it will take to get customers to return to the same levels as before the interruption occurred.
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Describe two situations in which a small physical damage loss can cause a large business income loss.
- 1) damage occurs in a "bottleneck" that can bring all operations to a standstill
- 2) damage results in pollution that will take a long time to clean up.
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Explain how seasonal fluctuations in income affect business income loss exposures.
If a business experiences seasonal fluctuation on its income, the severity of a business interruption can be much greater if the interruption occurs during a period when income is at its highest level. For such businesses, a short business interruption at the busiest season could cause a very severe buisness income loss.
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What factors should a company consider when determining payroll expenses during a business interruption?
- - Which employees are needed/not needed while operations are suspended?
- - Does the company have key employees who would be hard to replace?
- - Would the local labor market make it difficult to hire back laid-off employees?
- - Is the company a party to a union contract prohibiting layoffs?
- - Does the company have severance pay policies that discourage layoffs?
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Why is it important to update and project income and expense figures when estimating maximum business income loss?
It is important to update and project income and expense figures because the analyst is attempting to estimate the probable maximum loss for an event that will happen in the future.
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Why is the business income worksheet called a report/worksheet?
Because it is used to report business income values to the insurer when either the agreed value option or the premium adjustment endorsement applies. It is also called a worksheet because it is used to calculate the amount of insurance needed to comply with the coinsurance clause.
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How does the calculation of operating income for a service business differ from the calculation of operating income for a merchandising business?
An income statement for merchandising business differs from an income statement for a service business in that the merchandiser's income statement includes an additonal element: cost of goods sold.
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What requirements does the business income worksheet make with regards to (a) accounting basis and (b) inventory method used?
- (a) The worksheet requires the preparer to use the accrual basis (as opposed to cash basis) of accounting.
- (b) The worksheet does not require that a particular inventory method be used. However, the worksheet does require that the same method be used for the entire year's inventory figures. (FIFO, LIFO)
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Why does the business income worksheet seperate manufacturing and nonmanufacturing operations?
The worksheet seperates manufacturing and nonmanufacturing operations because the business income exposure for nonmanufacturing firms is based on loss of sales, whereas the business income exposure for a manufacturer is based on the loss of production (or "net sales value of production"). Calculating the net sales value of production requires additional computations.
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What items are deducted from gross sales value of production (item D of the worksheet) in order to arrive at net sales value of production (item F for a manufacturer)?
These items are deducted from gross sales value of production to arrive at net sales value of production for a manufacturer: (1) prepaid freight, (2) returns , (3) discounts, (4) bad debts, and (5) collection expenses.
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Summarize the worksheet calculation of "cost of goods sold" for a nonmanufacturing firm.
To calculate cost of goods sold for a nonmanufacturer, start with the beginning inventory. Then add to that amount the following: (1) the cost of merchandise purchased during the accounting period to sell to others and (2) other supplies consumed. Finally subtract the inventory at the end of the year.
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How does cost of goods sold as calculated in the business income worksheet differ from the cost of goods sold as shown in the income statement for a manufacturing firm?
Income statements for manufacturing firms include direct labor and factory overhead in the calculation of cost of goods sold. Neither labor nor overhead is included in the cost of goods sold in the business income worksheet.
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Why does overstatement of cost of goods sold for purposes of the worksheet result in understatement of net income?
In the worksheet, the cost of goods sold is subtracted from total revenues to arrive at the business income exposure for 12 months. If the higher figure for cost of goods sold (from the income statement) is subtracted from total revenues, the result will be lower than if the lower figure for cost of goods sold (as calculated in the worksheet) had been used.
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What items are deducted from total revenues when calculating "business income exposure for 12 months" under the business income worksheet?
- 1. Cost of good sold
- 2. Cost of services purchased from outsiders
- 3. Power, heat, and refrigeration expenses that do not continue under contract (if excluded by endorsement)
- 4. Ordinary payroll expense (if excluded by endorsement)
- 5. Special deductions for mining properties
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What is the purpose of the second set of columns that must be filled in on the business income worksheet?
The second (right-hand) set of columns is to show projections of the first set of numbers. These projections are for the twelve-month period during which the business income coverage will be in effect.
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Mail Order, Inc, suffered a fire loss at its single warehouse. During the six-month restoration period that followed, Mail Order's sales decreased from an expected $20 million to an actual $10 million, and (mainly because of extra expense for temporary relocation and rental expenses) expenses increased from an expected $10 million to an actual $15 million.
a. What was Mail Order's net income for the six-month period of restoration?
- a. Net income equals revenues minus expenses. Therefore, for the six-month period, Mail Order's net income was $10,000,000 - $15,000,000 =
- -$5,000,000.
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Mail Order, Inc, suffered a fire loss at its single warehouse. During the six-month restoration period that followed, Mail Order's sales decreased from an expected $20 million to an actual $10 million, and (mainly because of extra expense for temporary relocation and rental expenses) expenses increased from an expected $10 million to an actual $15 million.
b. What would Mail Order's net income have been for the same six-month period if no loss had occurred?
b. If no loss had occurred, Mail Order's income would have been $20,000,000 - $10,000,000 = $10,000,000
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Mail Order, Inc, suffered a fire loss at its single warehouse. During the six-month restoration period that followed, Mail Order's sales decreased from an expected $20 million to an actual $10 million, and (mainly because of extra expense for temporary relocation and rental expenses) expenses increased from an expected $10 million to an actual $15 million.
c. What was the amount of Mail Order's business income and extra expense loss for the six-month period?
c. The business income and extra expense loss was the difference between what Mail order's net income would have been and what it actually was: $10,000,000 -(-$5,000,000) = $15,000,000.
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Mail Order, Inc, suffered a fire loss at its single warehouse. During the six-month restoration period that followed, Mail Order's sales decreased from an expected $20 million to an actual $10 million, and (mainly because of extra expense for temporary relocation and rental expenses) expenses increased from an expected $10 million to an actual $15 million.
d. Could Mail Order's business income loss have continued after it resumed operations in its rebuilt warehouse? Explain why or why not.
d. yes. Sales could be lower than they would have been had no loss occurred. It may take several weeks or months for Mail Order to regain customers who have formed new buying habits.
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F&E Distributing Compnay is a hardware wholesaler that operates out of three warehouses in a tri-state area. F&E has completed a business income worksheet showing projected "net income and expenses" of $5 million for the twelve months following policy inception. F&E has also estimated its maximum business income loss at $2 million. F&E wants to insure its full business income exposure and to avoid coinsurance penalties but does not want to buy more insurance than it needs. (Assume the F&E cannot obtain business income coverage without a coinsurance clause.)
a. What factors micght account for the difference between F&E's business income basis for coinsurance and its estimated maximum loss?
- a. Any of these account for the differnce between the worksheet value and the estimated loss:
- - noncontinuing expenses not deducted in the worksheet
- - The time required to restore property
- - Anticipated changes in expenses and income during the period of restoration
- - Peak periods/seasonal fluctuations
- - Business income losses continuing after restoration of the property (extended business income loss)
- - Extra Expenses
- - Possible errors in worksheet projections
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F&E Distributing Compnay is a hardware wholesaler that operates out of three warehouses in a tri-state area. F&E has completed a business income worksheet showing projected "net income and expenses" of $5 million for the twelve months following policy inception. F&E has also estimated its maximum business income loss at $2 million. F&E wants to insure its full business income exposure and to avoid coinsurance penalties but does not want to buy more insurance than it needs. (Assume the F&E cannot obtain business income coverage without a coinsurance clause.)
b. Recommend an appropriate coinsurance percentage and amount of business income insurance for F&E, and justify your recommendation.
b. The estimated loss is less than 50 percent of worksheet coinsurance basis. Therefore, 50 percent coinsuranc and a limit of $2,500,000 (calculated as 0.50 x $5,000,000) are appropriate.
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F&E Distributing Compnay is a hardware wholesaler that operates out of three warehouses in a tri-state area. F&E has completed a business income worksheet showing projected "net income and expenses" of $5 million for the twelve months following policy inception. F&E has also estimated its maximum business income loss at $2 million. F&E wants to insure its full business income exposure and to avoid coinsurance penalties but does not want to buy more insurance than it needs. (Assume the F&E cannot obtain business income coverage without a coinsurance clause.)
c. Assume the F&E's estimate of maximum loss was $3.8 million instead of $2 million. Recommend an appropriate coinsurance percentage and amount of insurance, and justify your recommendations.
- c. $3,800,000/$5,000,000 = 76%
- A coinsurance percentage of 80% and a limit of $4,000,000 (calculated as 0.80 x $5,000,000) are appropriate.
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F&E Distributing Compnay is a hardware wholesaler that operates out of three warehouses in a tri-state area. F&E has completed a business income worksheet showing projected "net income and expenses" of $5 million for the twelve months following policy inception. F&E has also estimated its maximum business income loss at $2 million. F&E wants to insure its full business income exposure and to avoid coinsurance penalties but does not want to buy more insurance than it needs. (Assume the F&E cannot obtain business income coverage without a coinsurance clause.)
d. Assume the F&E's estimate of maximum loss was $6.5 million. recommend an appropriate coinsurance persentage and amount of insurance, and justify your recommendations
- d. $6,500,000/$5,000,000 = 130%
- Because 125% is the highest available coinsurnace persentage (and receives the lowest rate), it would be used. Limit should be set at $6,500,000 to cover the estimated maximum loss.
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