Accounting For Insurance Claim Settlements
Insurance is a necessity in any business. Businesses cover themselves against losses such as fire, theft and unexpected natural disasters. It is with the bookkeeping or accounting that owners get it wrong.
On successful insurance claims, a payment is typically made to the insured. My experience has led me to believe that small businesses have no clue, as to how, to explain insurance settlements. Most businesses mirror the payment as income.
Not only would this be misleading but also violates International Accounting Standards. Since the transaction has everything to do with assets and nothing to do with income, it should be modificated against assets. Erroneous accounting for assets might prejudice the business further in future, if similar insurance claims are made.
Insurance companies settle claims on assets, on its book value and not its costs. (And in addition the asset was insured on its cost at date of buy). while this rule might vary from country to country, book value is widely accepted as the norm. Since most small businesses fail to continue proper fixed assets registers, insurance companies perform desk top valuations, or make an calculate, on the book value, mostly much lower than its real book value. Without proper records, the claimant cannot debunk the assessors final conclusions.
Before I loose you in a sea of confusion, let me elaborate. If an asset is on your books at the minimum, without the asset register, but you have no buy date, and this asset is lost due to theft, no accurate use and tear can be furnished. Furthermore, if a claim is settled, and reflects as income, what happens to the asset that was stolen, but nevertheless reflects on your books?
Many reading this article could not care a hoot about the number crunching involved, but please stay with me for a minute. You might not care, but an investor, a bank and yes, the insurance company might pick this up on your financial statements when they need your reports.
The method used to explain insurance claims is the disposal method. Any asset unprotected to an insurance claim should be transferred to a Disposal Account. Depreciation on the asset for the applicable period is calculated, and credited to the disposal account with the insurance settlement. The cost, less depreciation equals book value. Any settlement amounts over or under book value, will consequence in a loss or profit on disposal.
An insurance claim, wrongly entered as income, can be modificated by transferring the amount to the disposal account. After effecting these entries, the disposal account should balance to zero. Your new records would show, the loss or profit on claim (income statement), settlement in bank account, fixed assets less the stolen/lost asset, and a lower depreciation calculate for the year.
I concede that this is your accountants job, you however have a duty to provide accurate records. But how many businesses continue to pay, the same insurance premiums on the assets, since buy date, when they, entitled to a lower premium, due to a lower asset value.(prior to any asset losses).
Also, a precarious asset situation in your books, might rule to problems in your tax affairs.
No business can provide a visit from the IRS. Did you know that tax authorities always commence auditing, your assets, before they move on to your income?