How Should Insurance Proceeds Be Accounted For
The accounting for insurance proceeds depends on the nature of the loss that the insurance claim compensates.
- Loss of Asset: If the insurance proceeds compensate for the loss of an asset (such as damage to a building or equipment from a natural disaster), the proceeds are typically used to offset the carrying amount (book value) of the asset. If the proceeds exceed the carrying amount of the asset, the excess is recorded as a gain. Conversely, if the proceeds are less than the carrying amount of the asset, the difference is recorded as a loss.For example, if a company receives $20,000 from an insurance company for a piece of equipment that was destroyed in a fire and had a book value of $15,000, it would record a $5,000 gain.
- Business Interruption: If the proceeds compensate for lost profits due to business interruption, they are generally recognized as other income in the period in which the interruption occurred.
- Liability Claims: If the proceeds are from an insurance policy covering legal liabilities, they are used to offset the associated liability or expense.For example, if a company faced a lawsuit for which it was insured, the insurance proceeds received would offset the associated legal expenses or liability recorded.
In all these scenarios, insurance proceeds should be recorded when they can be reliably measured and it is probable they will be received – consistent with the principles of revenue recognition.
It’s also important to note that the tax treatment of insurance proceeds can be complex and may differ from the accounting treatment. Entities should consult with a tax professional to ensure they comply with all applicable tax laws and regulations.
Lastly, the specific accounting treatment can vary depending on the accounting standards followed by the company (such as US GAAP or IFRS) and specific circumstances of the transaction.
Example of How Insurance Proceeds Should Be Accounted For
Let’s consider an example involving a loss of an asset:
Suppose XYZ Corporation owns a delivery truck with a book value (cost minus accumulated depreciation) of $20,000. Unfortunately, the truck is involved in an accident and is considered a total loss. XYZ Corporation files a claim with its insurance company and receives insurance proceeds of $25,000, as that was the current market value of the truck.
The accounting entries for this scenario would be:
Dr. Cash (or Bank) $25,000 (debit the asset account for the amount received)
Cr. Accumulated Depreciation $20,000 (remove the net book value of the truck from the books)
Cr. Gain on Insurance Settlement $5,000 (recognize the gain from the insurance proceeds)
The gain is recognized because the insurance proceeds exceeded the book value of the truck. This gain would typically be reported in the income statement as a non-operating item.
Please note that this is a simple example and actual accounting treatment can vary based on multiple factors, including the specifics of the insurance policy, accounting policies of the company, and applicable accounting standards. Also, the tax treatment can differ, so it’s important to consult with a tax professional or an accountant.
