Whether property is damaged by a natural disaster or taken without an owner’s consent, businesses must be prepared to minimize economic harm and maximize financial relief by referring to Generally Accepted Accounting Principles (GAAP) for involuntary conversions. 

Also referred to as involuntary exchanges, the tax code recognizes four kinds of involuntary conversions to property that is: 

  • destroyed by weather, fire or other hazards; 
  • stolen; 
  • condemned (taken by the government for public use); or 
  • disposed of under the threat of condemnation 

Once the property is replaced by another asset, such as cash or insurance proceeds, properly recognizing gains and losses is critical. A few things to keep in mind when it comes to recording your journal entries: 

  • If the asset loss (building) occurs in one year, and the monetary proceeds (cash) are received the following year, the assets lost should be recorded as a disposition from the books. 
  • Monetary proceeds should not be recorded unless the value is determinable (i.e., the insurance company has communicated the value of proceeds to be received). 
  • If the monetary proceeds are in excess of the total loss, the incremental benefit cannot be recognized until the cash is received. 
  • The asset loss, monetary proceeds received and property rebuild should be treated as three separate transactions. For example: 

Should a natural disaster occur to property with an asset cost of $1,000,000 and accumulated depreciation of $500,000, the journal entry would be recorded as such: 

Dr. Accumulated depreciation $500,000
Dr. Gain/loss on disposal of assets $500,000
     Cr.  Building $1,000,000 

If insurance proceeds totaled $650,000, you would record the following journal entry as either a receivable or cash once the amount is known and probable: 

Dr. Cash/receivable $650,000
     Cr. Gain/loss on disposal of assets $650,000 

It is important to note that all funds including the insurance proceeds received to rebuild the store and spent on capital expenditures should be capitalized and depreciated over the useful life.  It is not appropriate to net the capital expenditures against the insurance proceeds received. If the cost to rebuild the restaurant was $700,000, you would record the following: 

Dr. Building $700,000
     Cr. Cash $700,000 

GBQ’s Restaurant Team stands ready to empower growth; contact them today to discuss this information in more detail. 

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Tags: Audit/GAAP