Alyssa Lane
Insurance proceeds refer to the cash payment received by an insured party from its insurer in response to a claim. The proceeds are paid out to indemnify the insured party for a loss covered under the policy. The accounting procedures for insurance proceeds depend on the nature of the claim and whether the insurance company reimbursed the loss. If the insurance company covers the entire loss, the full amount of the insurance proceeds and the loss are recorded. If the insurance company does not cover the entire loss, the difference between the proceeds and the loss is recorded as a gain or loss. In some cases, the insurance proceeds may be recorded in a separate account labelled as Gain from Insurance Claims to indicate that it is non-operational in nature.
| Characteristics | Values |
|---|---|
| Definition | Insurance proceeds are the monies an insurance company pays to cover any financial loss. |
| Timing of recording | It is reasonable to wait until the proceeds have been received by the company. Alternatively, record the gain as soon as the payment is probable and can be determined. |
| Accounting procedure | If the insurance company pays for the loss, an accountant should record the full amount of the insurance proceeds and the full amount of the loss. |
| Tax implications | In general, insurance proceeds are tax-free, though there are certain exceptions to this rule. |
| Reimbursement | The reimbursement amount depends on the property's fair market value at the time it was destroyed or damaged, and whether the policy has a coinsurance clause. |
| Separate account | A gain from insurance proceeds should be recorded in a separate account if the amount is material, clearly labeling the gain as non-operational. |
| Disclosure | It may be necessary to disclose in the financial statement footnotes the nature of the events resulting in insurance proceeds, the amount, and the income statement line item where the gain is recorded. |
| Business interruption | Insurance proceeds may compensate a company for lost profits caused by a specific external event, such as business interruption. |
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What You'll Learn
Accounting for insurance proceeds
Insurance proceeds refer to the cash payment received by an insured party from its insurer in response to a claim. They are benefits paid out on insurance policies to indemnify the insured for a loss covered under the policy. Before insurance proceeds are paid out, the claim must be evaluated to determine the extent of the payment. This involves assessing the contract, the extent of the damage, and sometimes police reports.
When accounting for insurance proceeds, the full amount of the proceeds and the full amount of the loss must be recorded. The reimbursement amount depends on the property's fair market value at the time it was destroyed or damaged, and whether the insurance policy has a coinsurance clause. A coinsurance clause is the dollar amount of coverage the insurance company requires you to carry on the asset. If the insurance company pays more than the remaining value of the asset, there will be a profit; if they pay less than the book value, there will be a loss.
For example, if $10,000 of inventory is damaged and the insurance proceeds are $12,000, the transaction should be recorded as a $12,000 debit to Cash-Fire Damage Reimbursement, a $10,000 credit to Inventory, and a $2,000 credit to Gain on Insurance Proceeds. If the insurance company does not cover the loss, the entire amount must be written off.
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, clearly labelling the gain as non-operational. 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.
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Tax implications
Generally, insurance proceeds are not taxed as income. However, there are certain exceptions to this rule. The tax implications of insurance claim proceeds can vary depending on individual circumstances and specific tax laws. It is always advisable to consult a Certified Public Accountant (CPA) or another tax professional to understand how these rules apply to your specific situation.
Medical Insurance Claims
Any medical claim made to insurance, whether as part of a settlement after an accident or a claim for a medical appointment, is typically not taxed. For example, if you incur medical expenses due to a car accident, your personal injury protection (PIP) coverage will reimburse you, and this amount will not be taxed. Similarly, if you pay premiums for a health or accident insurance plan through a cafeteria plan, and you didn't include the premium amount as taxable income, the disability benefits are fully taxable.
Life Insurance
Life insurance proceeds received as a beneficiary due to the death of the insured person are generally not taxed as income. However, any interest received from a life insurance payout or any money withdrawn from a cash-value life insurance policy while the insured person is still alive is counted as income and taxed accordingly. If a life insurance policy was transferred to you for cash or other valuable consideration, the insurance proceeds exclusion is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts.
Property Insurance Claims
Insurance claim proceeds used to cover the cost of property repairs or replacements are generally not considered taxable income. However, if the insurance proceeds for personal property exceed the original cost (or adjusted basis) of the items, the excess may be considered a gain and could be subject to tax. On the other hand, if the reimbursement is less than the adjusted basis of the personal property, the difference may qualify as a casualty loss deduction, subject to certain limitations.
Business Interruption Insurance
Proceeds from business interruption insurance are typically considered taxable income as they compensate for lost profits. However, expenses paid out of the insurance proceeds may still be deductible. Additionally, if the insurance proceeds are used to pay for ongoing business expenses like payroll, rent, or utilities, these expenses can generally be deducted from taxable income.
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Bookkeeping entries
Insurance proceeds refer to the cash payment received by an insured party from its insurer in response to a claim made. The proceeds are used to cover any financial losses resulting from an adverse situation.
When accounting for insurance proceeds, you must remove the value of the damaged assets from your books and record the proceeds. The bookkeeping entries required to record the funds depend on whether your claim was related to an asset or general damages.
For a claim not related to a fixed asset
If your claim is not related to a fixed asset, the bookkeeping process is straightforward. Record the repair expenses as you normally would. Once you deposit the insurance cheque, credit the repair expense account instead of crediting an income account.
For a claim related to a fixed asset
If your claim is related to a fixed asset, you must record the full amount of the insurance proceeds and the full amount of the loss.
For example, if $10,000 of inventory is damaged and the insurance proceeds are $12,000, record the transaction as a $12,000 debit to Cash-Fire Damage Reimbursement, a $10,000 credit to Inventory, and a $2,000 credit to Gain on Insurance Proceeds.
If the insurance company does not cover the entire loss, you must write off the remaining amount. For example, if $9,000 of inventory is damaged in a fire, record the loss as a $9,000 debit to Fire Loss, and a $9,000 credit to Inventory.
For a claim related to asset disposal
If the insurance claim is related to the disposal of an asset, you must remove the asset from your books. Create a new account in your chart of accounts titled "Asset Disposal" and select "Fixed Asset" as the Account Subtype. Debit the remaining book value to the Asset Disposal account and credit the remaining book value to the original asset account. Once you deposit the insurance cheque, record it as a refund.
For a claim related to business interruption
Insurance proceeds may compensate a company for business interruption due to lost profits caused by a specific external event. In this case, the proceeds are accounted for as reimbursements and recognised as a separate asset when recovery is virtually certain. Recognise a receivable only when there is an unconditional right to receive the compensation for business interruption.
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Timing of recognition
The timing of recognition of insurance proceeds depends on the nature and timing of the insured event. It is generally advisable to wait until the proceeds have been received by the company before recording them. This eliminates the risk of recording a gain related to a payment that is never received.
However, an alternative is to record the gain as soon as the payment is probable and the amount can be determined. This constitutes a form of accrued revenue and is discouraged unless there is a high degree of certainty regarding the payment. For example, if there is an enforceable insurance contract in place that covers the event causing the loss, an insurance recoverable asset can be recorded.
In the case of a claim related to a fixed asset, the insurance check should be recorded as a refund once deposited in the bank account. If the insurance company paid out more than the remaining value of the asset, the difference is profit. If the payout was less than the book value, it is a loss.
For companies, insurance proceeds may reimburse some or all of the expenditure necessary to settle a provision. Insurance proceeds to settle a provision are recognised as a separate asset (with related income) when recovery is virtually certain. A company recognises compensation for business interruption as a receivable when it has an unconditional right to receive the compensation.
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Reimbursement and compensation
Insurance proceeds refer to the cash payment received by an insured party from its insurer in response to a claim made. The claim must be fully evaluated to determine the extent of the payment before the proceeds are paid out. 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. An alternative is to record the gain as soon as the payment is probable and can be determined, but this 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.
For example, if an insurance company pays for the loss, an accountant should record the full amount of the insurance proceeds and the full amount of the loss. Consider a fire that destroys $15,000 of inventory belonging to Company X. Since the insurance company covers the entire loss, the first entry is a $15,000 debit to fire damage, and a $15,000 credit to inventory to remove the inventory from the accounting books. The second entry is a $15,000 debit to cash-fire damage reimbursement and a $15,000 credit to fire damage. This procedure zeroes out the amount of the fire damage loss on Company X's books.
If the proceeds check is larger than the loss, the surplus is recorded as a gain. If $10,000 of inventory is damaged, and the insurance proceeds are $12,000, record the transaction as a $12,000 debit to cash-fire damage reimbursement, a $10,000 credit to inventory, and a $2,000 credit to gain on insurance proceeds.
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Frequently asked questions
Insurance proceeds are the monies an insurance company pays to cover any financial loss. They are paid out once a claim has been verified.
Your accounting entry depends on whether or not your insurance company reimbursed you for the loss. If the insurance company covers the entire loss, you would make the following entries: a $15,000 debit to fire damage, and a $15,000 credit to inventory to remove the inventory from your accounting books. The second entry is a $15,000 debit to cash-fire damage reimbursement, and a $15,000 credit to fire damage.
If $10,000 of inventory is damaged and the insurance proceeds are $7,000, the transaction should be recorded as a $7,000 debit to cash-fire damage reimbursement, a $3,000 debit to loss on insurance proceeds, and a $10,000 credit to inventory.
If the claim is related to an asset, you'll need to remove the asset from service and the account books. If you haven't disposed of an asset before, you'll need to create a new account in your chart of accounts. It's an asset account; just title it Asset Disposal and select Fixed Asset in the Account Subtype line.
In general, insurance proceeds are tax-free, though there are certain exceptions to this rule. For example, if a life insurance policy was transferred to you for cash, the insurance proceeds exclusion is limited to the sum of the consideration you paid.
