Accounting Treatment for Involuntary Conversions

By definition, an involuntary conversion is a mandatory liquidation of assets, such as a loss due to destruction (i.e., fire, hail, flooding, hurricane, tornado, etc.), theft, condemnation, or repossession, and the lost property is replaced by another asset such as cash or insurance proceeds.

Under generally accepted accounting principles (GAAP), the difference between the asset lost (building) and the asset received (cash) is then recognized as a gain or a loss. If the loss occurs in one year and the proceeds from the insurance company are received in the following year, then the assets lost should be recorded as a disposition from the books. The assets to be received, however, should not be recorded unless the assets to be received are determinable (i.e., the insurance company has already provided you with the amount of insurance proceeds you will receive). Moreover, if the total insurance recoveries amount to more than your total loss, you cannot recognize the incremental benefit until the cash is received.

For example, if you lose a restaurant due to fire damage in 2015 with an asset cost of $500,000 and accumulated depreciation of $250,000, you would record the following journal entry:
   Accumulated depreciation $250,000
   Gain/loss on disposal of assets $250,000
   Building  $500,000

If you received insurance proceeds totaling $300,000, you would record the following journal entry:
   Cash $300,000
   Gain/loss on disposal of assets  $300,000
If you are required to or choose to rebuild the restaurant, all costs to rebuild the restaurant using insurance proceeds should be capitalized, even if you do not own the building (lessee). The costs should not be netted against the insurance proceeds. If the cost to rebuild the restaurant was $375,000, you would record the following journal entry:
   Building $375,000
   Cash  $375,000
The important thing to remember is that the loss, the receipt of the insurance proceeds, and the rebuild should all be treated as separate transactions.

This post previously ran on the Selections blog on June 12, 2013

For more information on accounting treatment for involuntary conversions, contact Dustin Minton at [email protected], and be sure to keep up with the Practice’s latest thoughts by following us on Twitter at @BDORestaurant.