Various Types of Transactions – Part 4e, Collection from Other Source of Revenue and Income (Compensation Received for Loss of Assets)

Business entities may encounter some unfortunate events such as fire, flood or others that cause damage to their assets. After assessment of the damages caused, the insurance companies will then pay the relevant compensation to these business entities. If the assets damaged are fixed assets, the relevant double entries involved in the recording of the loss of the assets have been illustrated in my post: Various Types of Transactions – Pat 4d, Collection from Other Source of Revenue and Income (Proceeds from Disposal of Assets)

However, if the damaged assets are inventories or stocks, the carrying value of the inventories or stock should be deducted against the compensation received to determine the net loss:-

	$
Compensation received	XXXX
Carrying value of inventories	(XXXX)
Loss on damaged inventories	(XXXX)*

*Loss is shown here because the amount of compensation paid by the insurance company would normally not exceed the carrying value of the inventories.

The double entries involved in the recording of the recognition of the loss of damaged inventories are different, depending on the method of recording inventories in the general ledger, i.e. Perpetual Method or Periodic Method. Please refer to my post: Inventories or Stocks – Part 2, Methods of Recording in General Ledger for detailed illustrations of these two methods.

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 1 January 2006, ABC Co. Ltd paid cash to purchase 1,000 trading goods of $20 each. On 31 July 2006, 800 units were sold at $25 each. On 30 September 2006, 100 units were damaged due to flood. On 15 October 2006, ABC Co. Ltd received a cheque of $1,800 from the insurance company as compensation.

Perpetual Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Inventories	20,000
   Cash at bank		20,000

2. On 31 July 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Cash at bank	20,000
   Sales				20,000

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Cost of sales			16,000
   Inventories		*16,000

   *800 units X $20 per unit

3. On 30 September 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Loss on damaged inventories			2,000
   Inventories		2,000

4. On 15 October 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Cash at bank	1,800
   Loss on damaged inventories				1,800

The income statement and extract of the balance sheet of ABC Co. Ltd. are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006
	$
Sales	20,000	A
Less: Cost of Sales	16,000	B
Gross profit	4,000	C = A - B
Other income	-
Operating expenses: -
Loss on damaged inventories (2,000 - 1,800)	- 200	D
Net profit for the year	3,800	E = C + D
Extract of the Balance Sheet as at 31 December 2006
	$
Current assets
Inventories	2,000
Trade receivables	XXXX
Other receivables, deposits & prepayments:
Rental receivable	XXXX
Rental deposit	XXXX
Utility deposit	XXXX
Cash and bank balances	XXXX
	XXXX

Periodic Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Cost of sales - Purchases			20,000
   Cash at bank		24,000

2. On 31 July 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Cash at bank	20,000
   Sales				20,000

3. On 30 September 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Loss on damaged inventories			2,000
   Cost of sales – Transfer to loss on damaged inventories				2,000

4. On 15 October 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Cash at bank	1,800
   Loss on damaged inventories				1,800

5. On 31 December 2006

   	Balance Sheet		Income Statement
   	DR	CR	DR	CR
   Inventories	*2,000
   Cost of sales – Closing inventories				2,000

   *This closing inventories balance is usually determined by way of conducting a stock counting exercise at year end - 100 units X $20 each.

The income statement and extract of the balance sheet of ABC Co. Ltd. are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006
	$
Sales	20,000	A
Less: Cost of Sales
Opening inventories	-
Purchases	20,000
Transfer to loss on damaged inventories	- 2,000
Closing inventories	- 2,000
	16,000	B
Gross profit	4,000	C = A - B
Other income	-
Operating expenses
Loss on damaged inventories (2,000 - 1,800)	- 200	D
Net profit for the year	3,800	E = C + D
Extract of the Balance Sheet as at 31 December 2006
	$
Current assets
Inventories	2,000
Trade receivables	XXXX
Other receivables, deposits & prepayments:
Rental receivable	XXXX
Rental deposit	XXXX
Utility deposit	XXXX
Cash and bank balances	XXXX
	XXXX