Insurance protection minimizes risk of loss. Casualty insurance covers such items as fire loss and water damage. The premiums are typically paid in advance and debited to Prepaid Insurance, which is then amortized over the policy period. Casualty insurance reimburses the holder for the fair market value of lost property. How insurance reimbursement computed and accounted? This post answers the questions. Enjoy!
Insurance companies usually have a coinsurance provision so that the insured bears a portion of the loss. The insurance reimbursement formula follows [assumes an 80 percent coinsurance clause]:
Possible reimbursement = [(Face of policy/(0.8 × Fair market value of insured property)] × Fair market value of loss
Insurance reimbursement is based on the lower of the face of the policy, fair market value of loss, or possible reimbursement.
Case Face of Fair Market Fair Market
Policy Value of Value of
A $ 4,000 $10,000 $ 6,000
B 6,000 10,000 10,000
C 10,000 10,000 4,000
Insurance reimbursements are as follows:
- Case A: [$4,000/(0.8 × $10,000)] × $6,000 = $3,000
- Case B: [$6,000/(0.8 × $10,000)] × $10,000 = $7,500
- Case C: [$10,000/(0.8 × $10,000)] × $4,000 = $5,000
A blanket policy covers several items of property. The face of the policy is allocated based on the fair market values of the insured assets.
A blanket policy of $15,000 applies to equipment I and equipment II. The fair values of equipment I and II are $30,000 and $15,000, respectively. Equipment II is partially destroyed, resulting in a fire loss of $3,000.
The policy allocation to equipment II is computed as:
Fair Market Value Policy
Equipment I $30,000 $10,000
Equipment II 15,000 5,000
The insurance reimbursement is:
[$5,000/(0.8 × $15,000)] × $3,000 = $1,500
When there is a fire loss, the destroyed asset must be removed from the books. Fire loss is charged for the book value of the property. The insurance reimbursement reduces the fire loss. The fire loss is an extraordinary item shown net of tax.
Merchandise costing $5,000 is fully destroyed. There is no insurance for it. Furniture costing $10,000 with accumulated depreciation of $1,000 and having a fair market value of $7,000 is fully destroyed. The policy is for $10,000. Building costing $30,000 with accumulated depreciation of $3,000 and having a fair market value of $20,000 is 50 percent destroyed. The face of the policy is $15,000. The journal entries to record the fire loss on the books follow:
[Debit]. Fire loss = $9,000
[Debit]. Accumulated Depreciation = $1,000
[Credit]. Furniture = $10,000
[Debit]. Fire loss = $13,500
[Debit]. Accumulated depreciation = $1,500
[Credit]. Building = $15,000
Insurance reimbursement totals $16,375, computed as:
- Furniture: [$10,000/(0.8 × $7,000)] × $7,000 = $12,500
- Building: [$15,000/(0.8 × $20,000)] × $10,000 = $9,375
The journal entry for the insurance reimbursement is:
[Debit]. Cash = $16,375
[Credit]. Fire loss = $16,375
The net fire loss is = $27,500 – $16,375 = $11,125