Insurance is a necessity in any business. Businesses cover themselves against losses such as fire, theft, and unexpected natural disasters. It is with bookkeeping or accounting that the owners err.

In successful insurance claims, a payment is typically made to the insured. My experience has led me to believe that small businesses don’t have a clue how to account for insurance settlements. Most companies reflect the payment as income.

This would not only be misleading but would also violate International Accounting Standards. Since the transaction has everything to do with assets and nothing to do with income, it must be adjusted against assets. Misaccounting of assets could further hurt the business in the future, if similar insurance claims are made.

Insurance companies settle claims on assets, on their book value and not on their costs. (And yet the asset was insured for its cost at the date of purchase.) While this principle may vary from country to country, book value is widely accepted as the norm. Since most small businesses do not keep proper records of fixed assets, insurance companies perform “desk valuations” or an “estimate” of book value, often much lower than their “true” book value. “. Without proper records, the claimant cannot discredit the appraiser’s final conclusions.

Before you get lost in a sea of ​​confusion, let me elaborate. If an asset is on your books at least without the asset record, but does not have a purchase date, and this asset is lost due to theft, an exact wear and tear cannot be provided. Also, if a claim is settled and is reflected as “income”, what happens to the asset that was stolen, but is still reflected on your books?

Many of you reading this article won’t give a damn about the number crunching involved, but stay with me for a minute. You may not care, but an investor, bank, and yes, insurance company could spot this in your financial statements when they require your reports.

The method used to account for insurance claims is the “disposition method.” Any assets subject to an insurance claim must be transferred to a “Disposition Account”. The depreciation of the asset is calculated for the corresponding period and credited to the disposal account with the insurance settlement. Cost, less depreciation, equals book value. Any settlement amount above or below book value will result in a gain or loss on disposition.

An insurance claim, entered incorrectly as “income”, can be adjusted by transferring the amount to the disposal account. After making these entries, the disposal account must be at zero. Your new records would reveal the claimed gain or loss (income statement), bank account settlement, fixed assets less the stolen/lost asset, and a lower depreciation estimate for the year.

I recognize that this is the job of your accountant; however, you have a duty to provide accurate records. But how many companies continue to pay the same insurance premiums on assets from the date of purchase, when they were entitled to a lower premium due to lower asset value? (before any loss of assets).

Likewise, a precarious financial situation on your books could cause you problems in your tax affairs.

No business can afford a visit from the IRS. Did you know that tax authorities always start auditing your assets before moving on to your income?