Definition
The term casualty insurance refers to an agreement whereby in exchange for the payment of a premium, an insurance company assumes some, or all, of the risk associated with the loss of assets due to fire, storms, theft and accidents.
When an asset is impaired, destroyed, or lost, a company must come to a settlement with the insurance company, and subsequently account for a gain or loss on the casualty event.
Explanation
The assets of a company are continually threatened by casualty events such as fire, storms, theft, and accidents. By entering into a contract with an insurance carrier, a company can mitigate the risk of a loss.
Companies will typically pay an insurance premium in advance for this service, which is classified as a prepaid expense. The premium charged will be a function of both the types of coverage provided, cost sharing arrangements such as coinsurance and copayments, as well as the dollar value of the assets insured.
The maximum payment provided by policies if an asset is lost is its fair market value on the date of the casualty. This is known as the insurable value of the asset. The book value of the asset is usually not taken into consideration when settling with the insurance carrier; it's only relevant to the calculation of a gain or loss.
Example
A widget maker owned by Company A was partially destroyed by an electrical fire. Company A purchased the widget maker for $210,000 three years ago. When initially purchased, the widget maker was thought to have a serviceable life of seven years.
The annual depreciation on the asset was calculated to be:
= $210,000 / 7, or $30,000 per year
After three years, the accumulated depreciation would be:
= $30,000 x 3, or $90,000
Company A carried casualty insurance on the widget maker for 80% of its insurable value. The current cost to replace the asset had grown to $220,000. Therefore, Company A was responsible for:
= $220,000 x 0.2, or $44,000
While the settlement with the insurance carrier was calculated as:
= $220,000 - $44,000, or $176,000
The gain or loss on the casualty would be calculated as:
Cost of Machinery | $220,000 |
Less: Accumulated Depreciation | $90,000 |
Net Book Value | $120,000 |
Proceeds from Insurance Policy | $176,000 |
Gain from Casualty | $56,000 |
The following journal entries are needed to remove the asset from the company's books:
Debit | Credit | |
Cash | $176,000 | |
Accumulated Depreciation | $120,000 | |
Gain on Disposal | $56,000 |
Related Terms
The accounting term used to describe an economic resource, which is owned by the corporation and expected to provide future benefits to its operation, is asset. Appearing on the balance sheet, assets are typically broken down into two categories:
Moneyzine EditorJanuary 5th, 2024- The financial accounting term prepaid expense refers to the portion of an advance payment that has not been used up at the end of an accounting period. Prepaid expenses are an asset and appear on a company's balance sheet.Moneyzine EditorSeptember 21st, 2023
The financial accounting term accumulated depreciation is used to describe a contra asset account that summarizes the total of all the depreciation of an asset that has occurred at a certain point in time.Moneyzine EditorJanuary 4th, 2024
The financial accounting term disposition of property, plant, and equipment refers to the disposal of the company's assets. This can include the sale, exchange, abandonment, and involuntary termination of the asset's service. Disposition of plant typically results in a gain or loss appearing on the company's income statement.Moneyzine EditorJanuary 16th, 2024- The term sale of property, plant, and equipment refers to the selling or exchange of the company's assets. When the sale of property, plant, or equipment occurs, the company must compare the asset's original purchase price and accumulated depreciation to its selling price to determine if there was a gain or loss on the transaction.Moneyzine EditorSeptember 21st, 2023
The term impairment in value is used to describe an event that suddenly and permanently lowers the value of an asset appearing on the company's balance sheet. When this occurs, companies will write-down the asset to the new market value. Accounts typically affected by impairment include goodwill as well as accounts receivable.Moneyzine EditorJanuary 19th, 2024- The financial accounting term service life is used to describe the period of time over which an asset can be expected to perform its intended use. Service life is typically limited by two factors: physical wear and obsolescence.Moneyzine EditorSeptember 21st, 2023
The financial accounting term holding gains and losses refers to increases and decreases to the replacement cost of an asset or the value of a liability. Holding gains and losses can be realized as well as unrealized.Moneyzine EditorJanuary 19th, 2024
