Paul Sanchez
When a business experiences a loss covered by an insurance policy, it may record a gain in the amount of the insurance proceeds received. This gain is recorded separately from the loss and does not affect the recorded amount of the loss. The recognition of a gain or loss occurs when a non-monetary asset, such as property or equipment, is involuntarily converted to monetary assets, such as insurance proceeds. The accounting treatment for insurance proceeds depends on the nature of the loss compensated by the insurance claim. If the insurance proceeds exceed the carrying amount of the lost asset, the excess is recorded as a gain. For example, if a company receives $25,000 from an insurance company for a delivery truck with a book value of $20,000, it would record a $5,000 gain. This gain is typically reported as a non-operating item in the income statement.
| Characteristics | Values |
|---|---|
| Recognition of gain or loss | Measured as the difference between the carrying amount of the non-monetary asset and the amount of monetary assets received |
| Accounting for purchased insurance arrangements | Follow retroactive insurance accounting for new insurance contracts |
| Accounting for insurance proceeds | Depends on the nature of the loss the insurance claim compensates |
| Loss of asset | If the insurance proceeds compensate for the loss of an asset, the proceeds are used to offset the carrying amount (book value) of the asset |
| Excess insurance proceeds | Excess proceeds are recognised as a gain when all contingencies related to receiving the payment are resolved |
| Timing of recording gain | Record the gain when the payment is probable and the amount can be determined |
| Recording gain prior to cash receipt | Offset the gain with a receivable for expected insurance recoveries |
| Recording gain in a separate account | If the amount is material, record the gain in a separate account, clearly labelling it as non-operational |
| Gain from insurance claims | The likely total outcome of an insurance claim is a net loss, as the amount of the claim is offset against the actual loss incurred, net of an insurance deductible |
| Recognition of insurance recovery | An asset relating to an insurance recovery should be recognised when realisation of the claim is deemed probable, and only to the extent of the related loss recognised |
| Recognition of loss | The loss should take salvage or resale value into consideration and should follow the guidance in ASC 360, Property, Plant, and Equipment, for computing impairment losses |
| Recognition of gain | A gain or loss should be recognised when a non-monetary asset is involuntarily converted to monetary assets, even if the entity reinvests or is obligated to reinvest the monetary assets to replace the non-monetary assets |
| Recovery of loss | The recovery of a loss is generally probable if there is a legally enforceable contract that stipulates the terms of the insurance coverage and the terms are not in dispute |
| Recognition of gain prior to receipt of cash | The expected gain portion can be recognised prior to receipt of cash when it is no longer contingent, such as when the insurance company acknowledges that a specified payment is due |
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What You'll Learn
Recognition of gain on involuntary conversion
When a business suffers a loss covered by an insurance policy, it recognises a gain in the amount of the insurance proceeds received. The most reasonable approach is to wait until the proceeds have been received by the company, thus avoiding the risk of recording a gain related to a payment that is never received. Alternatively, the gain can be recorded as soon as the payment is probable and the amount can be determined, although this is a form of accrued revenue and is discouraged unless there is a high degree of certainty regarding the payment. If the gain is recorded prior to cash receipt, the offsetting debit to the gain is a receivable for expected insurance recoveries. A gain from insurance proceeds should be recorded in a separate account if the amount is material, thereby clearly labelling the gain as non-operational.
Recognition of a gain or loss on an involuntary conversion is measured as the difference between the carrying amount of the non-monetary asset and the amount of monetary assets received. A non-monetary asset is considered property or equipment, while monetary assets refer to insurance proceeds. For example, if a company's production facility sustained significant damage due to a fire and the company received insurance proceeds of $40,000, the difference between the amount of damage and the insurance proceeds would be recognised as a gain.
In the case of involuntary conversions, the tax implications depend on the type of compensation received and its usage. If an individual receives money as compensation for their lost property and does not use it to purchase replacement property, the involuntary conversion is generally treated as a sale, resulting in a taxable capital gain. On the other hand, if the compensation is less than the property's basis, it may result in a capital loss that can be written off on taxes. Involuntary conversions of primary residences typically do not have tax consequences, even if the taxpayer does not purchase a new home or realises a capital gain or loss.
It is important to note that the accounting for insurance recoveries can be complex due to the involvement of contingencies. A potential insurance recovery should be evaluated and accounted for separately from the related loss, and it should not affect the recorded amount of the loss. An asset relating to an insurance recovery should be recognised only when the realisation of the claim is deemed probable and only to the extent of the related loss recognised.
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Accounting for purchased insurance arrangements
When it comes to purchased insurance arrangements, there are several key considerations. Firstly, the recognition of gains or losses is essential. A gain occurs when the insurance proceeds received exceed the recognised loss. For example, if a company suffers a loss of $50,000 due to property damage and receives insurance proceeds of $40,000, the net gain is $40,000. This gain is typically recorded separately as "Gain from Insurance Claims" to distinguish it from operational income.
The timing of recognising gains or losses is also important. The most conservative approach is to wait until the insurance proceeds are received before recording the gain, eliminating the risk of recognising a gain that may never be received. Alternatively, if there is a high degree of certainty, the gain can be recorded as soon as the payment is deemed probable and the amount can be reasonably determined. This constitutes accrued revenue and should be avoided unless there is strong evidence supporting the payment.
In the case of involuntary conversion, where a non-monetary asset is converted into monetary assets (such as insurance proceeds), a gain or loss should be recognised. This is calculated as the difference between the carrying amount of the non-monetary asset and the amount of monetary assets received. Additionally, when an entity purchases residual value insurance, it can be accounted for as a purchased insurance contract or a derivative, depending on the contract's characteristics.
It's worth noting that changing insurance programs can impact the accounting process. Modifications to coverage may result in underinsured or non-insured risks, requiring disclosures if the insurance coverage significantly differs from previous years or the policy type changes. Furthermore, the purchase of new insurance coverage does not immediately result in a gain or loss. Instead, retroactive insurance accounting is applied to the new contract, considering historical claims and pricing indications.
Overall, accounting for purchased insurance arrangements involves recognising gains or losses, timing the recognition appropriately, understanding involuntary conversions, and considering the impact of changing insurance programs. These practices help ensure accurate financial reporting and compliance with GAAP standards.
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Accounting for insurance proceeds
When a business suffers a loss that is covered by an insurance policy, it recognises a gain in the amount of the insurance proceeds received. The most reasonable approach to recording these proceeds is to wait until they have been received by the company. This way, there is no risk of recording a gain related to a payment that is never received.
An alternative is to record the gain as soon as the payment is probable and the amount can be determined. However, this constitutes accrued revenue and is discouraged unless there is a high degree of certainty regarding the payment. If the gain is recorded before cash is received, the offsetting debit to the gain is a receivable for expected insurance recoveries. A gain from insurance proceeds should be recorded in a separate account if the amount is material, clearly labelling the gain as non-operational. For example, the title of such an account could be "Gain from Insurance Claims".
While a gain is being recorded, the likely total outcome of an insurance claim is a net loss, as the amount of the claim is offset against the actual loss incurred, net of an insurance deductible. It may be necessary to disclose in the financial statement footnotes the nature of the events resulting in insurance proceeds, the amount of the proceeds, and the income statement line item in which the resulting gain is recorded.
When faced with property damage and other losses that an entity has insured itself against, questions arise regarding the accounting for that property damage and any related insurance recoveries. Specifically, when a loss is sustained in one fiscal period, but the related insurance recovery is not received until the next fiscal period, questions arise about the timing and amount of potential insurance recoveries to be recorded. Because FASB Accounting Standards Codification (ASC) 450, Contingencies, does not allow the recognition of gain contingencies, the accounting for insurance recoveries can be more complex. A potential insurance recovery should be evaluated and accounted for separately from the related loss and should not affect the recorded amount of the loss. An asset relating to an insurance recovery should be recognised only when the realisation of the claim is deemed probable, and only to the extent of the related loss recognised.
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Timing of recognition of insurance recoveries
The timing of the recognition of insurance recoveries is a complex process that depends on various factors. The recognition of a gain or loss occurs when a nonmonetary asset, such as property or equipment, is involuntarily converted into monetary assets, such as insurance proceeds. This is the case even if the entity reinvests or is obligated to reinvest the monetary assets to replace the nonmonetary assets.
The recognition of insurance recoveries should be evaluated and accounted for separately from the related loss. An asset relating to an insurance recovery should be recognized when the realization of the claim is deemed probable and only to the extent of the related loss recognized. The recovery of a loss is generally probable when there is a legally enforceable contract stipulating the terms of insurance coverage, which are not in dispute. If the claim is in litigation, it is presumed that realization is not probable.
The recognition of a gain related to an insurance recovery is not realized until all contingencies relating to the insurance claim have been resolved. This includes confirming that the loss event is covered, receiving information that confirms the amount to be received, and determining that collection is probable. If there is uncertainty regarding the existence of the claim, the applicability of coverage, or the final settlement amount, the gain should not be recognized until the final settlement.
It is important to distinguish between the recovery of a loss and the recognition of a gain. The recovery of a loss can be recognized when probable, while a contingent gain cannot be recognized until realized. The expected gain portion can be recognized before receiving cash when it is no longer contingent, such as when the insurance company acknowledges a specified payment due.
The timing of the initial recognition of an insurance recovery asset depends on assessing the enforceability of the claim and whether the expected proceeds will result in the recovery of a recognized loss or represent a gain contingency. A gain contingency occurs when the insured entity expects to recover a loss not yet recognized in the financial statements or when they expect to recover an amount exceeding the loss recognized.
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Gain on insurance settlement
When a business suffers a loss covered by an insurance policy, it may recognise a gain in the amount of the insurance proceeds received. This gain is recorded in a separate account and labelled as non-operational. For example, the account could be titled "Gain from Insurance Claims".
The recognition of a gain or loss on an involuntary conversion is measured as the difference between the carrying amount of the non-monetary asset and the amount of monetary assets received. A gain is recognised when a non-monetary asset, such as property or equipment, is involuntarily converted to monetary assets, such as insurance proceeds. This is the case even if the entity reinvests the monetary assets to replace the non-monetary assets.
The accounting for insurance proceeds depends on the nature of the loss that the insurance claim compensates. If the insurance proceeds compensate for the loss of an asset, such as damage to a building or equipment, 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. 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. This gain would be reported in the income statement as a non-operating item.
A potential insurance recovery should be evaluated and accounted for separately from the related loss and should not affect the recorded amount of the loss. An asset relating to an insurance recovery should be recognised only when the realisation of the claim is deemed probable and only to the extent of the related loss recognised. The recovery of a loss is generally probable if there is a legally enforceable contract that stipulates the terms of the insurance coverage, and these terms are not in dispute.
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Frequently asked questions
A gain on insurance refers to the amount of money received from an insurance company that exceeds the book value of the insured asset.
The accounting treatment for a gain on insurance depends on the nature of the loss that the insurance claim compensates. If the insurance proceeds compensate for the loss of an asset, the proceeds are used to offset the carrying amount (book value) of the asset. If the insurance proceeds exceed the carrying amount, the excess is recorded as a gain.
A gain on insurance should be recognized when the insurance proceeds are received. Alternatively, it can be recognized when the payment is probable and the amount can be determined, although this is discouraged as it constitutes accrued revenue.
A gain on insurance is typically recorded in a separate account, such as "Gain from Insurance Claims," and is reported in the income statement as a non-operating item. It is important to disclose the nature of the events resulting in insurance proceeds, the amount of the proceeds, and the income statement line item in the financial statements.
