Accounting for Involuntary Conversions
By: Dave Thomsen, CPA, Partner | email
This summer has seen an uptick in damages from natural disasters – weather – realized by several of our clients here in the Midwest. Funnel clouds and straight line wind storms have caused considerable wind damage, hail damage, water damage and structural damage to buildings, grains bins, equipment and vehicles. Luckily and most importantly, personal injury appears to be limited. For the most part, property can easily be replaced.
By definition, an involuntary conversion is a mandatory liquidation of assets (such as a loss due to fire, wind, flooding, or tornado). The lost property is normally replaced by another asset, such as cash from insurance proceeds. According to generally accepted accounting principles (GAAP), the difference between the value of the asset lost (property) and the value of the asset received (cash) is recognized in financial statements as a gain or loss. An involuntary conversion, and the resulting gain or loss, is considered to have occurred even if an entity reinvests the monetary assets with non monetary replacement assets.
It is important to keep information related to the event (dates, communications with insurers and vendors, insurance advances and settlements, invoices paid in connection with costs associated with the event) separate from “normal” operating activities. Items to consider as you prepare to track the transaction:
- Asset(s) lost – Identify the asset(s) lost or damaged in your detailed fixed asset schedule listing. Note the asset number, description, date acquired, cost and depreciation taken through the date of the loss.
- Inventories – Prepare schedules of grain stocks and merchandise inventory lost or damaged from DPR records, bin measurements, periodic inventory count sheets or perpetual inventory listings.
- Expenses – Record payments for demolition costs, debris removal, cleanup and other expenditures incurred subsequent to the date of the incident.
- Insurance proceeds – It is important to segregate insurance proceeds between the types of loss being replaced. Examples include: proceeds for coverage of property value of assets, coverage for lost inventory, coverage for debris removal and clean-up, and business interruption coverage.
- Timing – Often these types of transactions “straddle” fiscal year end reporting periods. Estimates can be made in order to record the complete transaction, however it is important to have as much and as accurate information as possible. Generally, recoveries that result in a gain should not be recognized until realized.
In addition to accounting for involuntary conversions in accordance with GAAP, there are rules on the income tax side that allows for an election to defer reporting and paying the income tax associated with a gain or loss on the involuntary conversion. Those rules include replacing the lost asset with similar like-kind property within a limited time period. If you have suffered such an unexpected occurrence recently and would like to discuss the GAAP and tax issues involved prior to your year end please let us know.
Our thoughts are with those affected by the recent storms.